A Better (Graphical) Benchmark for Monetary Policy? And a Simple Way to Integrate the Dual Goal Objective?

Resumo

The stable price goal of central banks is one of the most watched globally. This benchmark for the price index for personal consumption expenditures (PCEPI), currently just “2% p.a.”, is “under specified” and allows for a mismatch between what the Federal Reserve (Fed) believes its mandate to be and the impact on markets and citizens they are meant to serve. Instead, the Fed could take a page from the effective benchmarking practices of institutional investors (and learn from their mistakes) to set a simpler and more transparent benchmark that allows for the achievement of longer-term goals (and less examination of “collective dot plots”) and better governance at multiple levels. We propose an alternative and more realistic benchmark, which allows for better tracking of not only current inflation experience but also over the “longer run”, an unspecified time period in current Fed announcements, publications, press conferences, and minutes, AND of the dual mandate.
For one, the current “2% goal” is missing a volatility component (say a +1 or 2 standard deviation band), and for another “longer term” is not specified allowing it to be vague, possibly intentionally, but that does not serve the market and citizens any good. Most importantly, the 2% goal ignores the pernicious effect of compounding – a trivial insight but ignored in the goal statements and press conferences completely, and potentially policy. We show graphically how a new benchmark could be created that achieves a better potential outcome with greater specificity, and a visual representation of the objectives within the benchmark volatility cone, that even non-technical citizens can track. We conclude with a discussion of the application of this idea to other individual goals like GDP, Unemployment, QT and Net Zero, challenges for such goals, but most importantly demonstrate how the Fed could possibly combine targets for goals, as the Fed has a multi-goal objective. We recommend a PEACE (Personal Employment-Adjusted Consumption Expenditure) Price Index that incorporates both goals in a single target/chart. We close with a discussion of ensuring that Fed officials’ compensation is made incentive compatible with their goals.