Commentary
Sample story
Why the Fed Funds Rate Should Follow a Stated Rule
Published · Updated
Draft commentary, awaiting the publisher. A central bank that says in advance how it will act gives everyone else something to plan around.
The overnight rate the Federal Reserve targets is the most watched price in the economy. The New York Fed reports the effective federal funds rate at 3.88% for its latest stored print. Every mortgage, business loan and savings account is priced in its shadow. So the way that rate gets chosen matters more than almost any single number it lands on.
Today it is chosen by judgment, meeting by meeting. A committee reads the data, weighs the risks and decides. That sounds sensible. It is also the problem.
The claim
Milton Friedman argued that a central bank should follow a stated rule, not a mood. A rule does not have to be rigid or mechanical. It has to be public, simple enough to check, and binding enough that the bank cannot quietly drop it when it becomes inconvenient. If the bank says how it will respond to inflation and to unemployment, households and firms can plan, and they can tell when the bank has failed.
Discretion hides failure. When the bank can explain every choice after the fact, nobody can say it missed. A rule turns a promise into a test.
The strongest case against
The best objection is that the world does not follow a script. A rule written in calm years may do harm in a crisis, and a committee that cannot adapt may make a bad shock worse. The financial panic of recent memory is the example critics reach for, and they are right that a rule must have room for emergencies.
Why the claim still holds
An emergency clause is not a reason to have no rule. It is a reason to write the exceptions down. A bank that may depart from its rule must say that it has, and why, and when it will return. That is still discretion, but discretion on the record.
The cost of the current habit is uncertainty. Markets spend real money guessing what the next meeting will do. Savers and borrowers wait. Prices that should reflect fundamentals instead reflect guesses about a committee. A stated rule would not remove every surprise. It would remove the ones the bank creates for itself.
This is the paper’s opinion. It is not a finding of the Federal Reserve, and it predicts nothing about any coming decision.