At the Rocky Mountain Economic Summit last weekend, both James Bullard (President of the St. Louis Fed) and Charles Plosser (President of the Phildelphia Fed) discussed thresholds and triggers. They were referring to the view that the Fed should stop its asset-purchase programme (one part of quantitative easing) when the US unemployment rate gets down to 6.5%. They also mentioned a rate of inflation of 2.5% as a separate threshold.
The question that neither of them answered satisfactorily, though, was "what should the Fed do when the unemployment rate does get down to 6.5%? Is that threshold a signal something should change? or is it a hard trigger that will set off some action?"
These questions reminded me of the old "rules vs. discretion" arguments that were so common between the old-school Keynesians and Monetarists. The monetarists wanted the annual rate of growth of the money supply (measured as M2) to be set at 2%, while the Keynesians wanted the Fed to obfuscate use its wisdom to decide what to do.
The modern day version of that debate might be among supporters of using the Taylor Rule on one hand, versus those who want the Fed to have more flexibility on the other.
What perplexed me about the presentations of the two Fed Presidents was that neither had very good or very clear answers about what the Fed should do regarding the 6.5% threshold, though it seemed that Plosser favoured a harder trigger than did Bullard.
If everyone believes the 6.5% threshold is widely regarded as a trigger that will set off a slowdown in quantitative easing, then as we approach that threshold, there will be great speculation in both the press and the markets about if/when the Fed will take action the next month, or the next, or soon. Using the threshold as a trigger can be somewhat destabilizing, if anything, during those months during the approach to the threshold if people believe it is a hard trigger that will set off some kind of action.
Quite likely, despite language to the contrary from both the Fed Presidents, [e.g. Bullard: "a line in sand has to mean something"], neither one of them would favour using the 6.5% unemployment rate as a firm, hard threshold that would set off a huge change in monetary policy. Rather they would more likely (judging from the nuances of their answers to our questions) favour a policy that would begin slowing the asset purchases more the closer the unemployment rate gets to the threshold.... a kind of gradualism. But then, of course 6.5% is meaningless as a threshold. When should the change begin? and how much should be done as the economy approaches this threshold? And given the fuzziness, why even mention a threshold at all?
Plosser would like to begin winding down the asset-purchase programme now and Bullard would like to wait longer because he is concerned about the low measured rate of inflation. But if they're going to start now or next quarter, again it doesn't make much sense to call it a 6.5% unemployment rate a "threshold".
What does make sense, though, is trying to approach something like the Taylor Rule. I realize that the Taylor Rule itself would also create speculation about what the numbers would cause the Fed to do, but that is the case for every reaction function the Fed is seen to exercise. My major variation on the Taylor Rule would be somehow to incorporate expected inflation (derived from the TIPS data) and not use only measured, past inflation for that portion of the rule. As an added plus, these data are available in real time and would not cause the market gyrations during the lead-up and announcements of other economic data.
My attendance at the summit is supported by several sponsors, including the Department of Economics at The University of Regina.