New Bill Calls for Built in Money Printing by The Fed...

...via a mathematical formula that determines Federal Reserve fed funds target interest rate.

Alan Blinder explains:

 The bill under consideration is called the Federal Reserve Accountability and Transparency Act. (That's right: FRAT.)...the meat-and-potatoes of the House bill has little to do with either transparency or accountability...

As the title of Section 2 puts it, FRAT would impose "Requirements for Policy Rules of the Federal Open Market Committee." A "rule" in this context means a precise set of instructions—often a mathematical formula—that tells the Fed how to set monetary policy. Strictly speaking, with such a rule in place, you don't need a committee to make decisions—or even a human being. A handheld calculator will do...

About two decades ago, Stanford economist John Taylor began plumping for a...rule, one which forces monetary policy to respond to changes in the economy—but mechanically, in ways that can be programmed into a computer. While hundreds of "Taylor rules" have been considered over the years, FRAT would inscribe Mr. Taylor's original 1993 version into law as the "Reference Policy Rule." The law would require the Fed to pick a rule, and if their choice differed substantially from the Reference Policy Rule, it would have to explain why...

In a town like Washington, the message to the Fed would be clear: Depart from the original Taylor rule at your peril...

So what is this rule that FRAT would turn into holy writ? It's a simple equation, which starts by establishing a baseline federal-funds rate that is two percentage points higher than inflation; that's about 3.5% now. It then adds to that baseline one-half of the amount by which inflation exceeds its 2% target (that "excess" is now roughly minus 0.5%). Next, it adds one-half the percentage amount by which gross domestic product exceeds an estimate of potential GDP (that gap is controversial but is perhaps minus 4% today). Thus Taylor's mechanical rule wants the current fed-funds rate to be about 3.5 – 0.25 – 2.0 = 1.25%—which is vastly higher than the actual near-zero rate.

Of course, the problem with this formula is that it completely ignores free market interest rate determination and would result in erratic changes in money supply growth. SEE: Murray Rothbard in Austrian School Business Cycle Theory for the best discussion of how interest rates and money supply manipulations cause the business cycle.

There is no need for a formula to determine interest rates. In fact,  it is a special form of price control that can lead to shortages or oversupplies, since it will generally result in a rate that would be different from market rates. In the case of controls on interest rates via the Fed, it is credit that will find itself at greater or lesser levels than would occur in a free market.

It is economic technocrats like Taylor, who simply hate free market and who are mesmerized by mathematical formulas, that attempt to plan out and distort natural market conditions. There is no need for such mathematical formulas, they are dangerously distorting, as are all manipulations of interest rates by the Federal Reserve.

-RW