Tag Archives: Fed Oversight Reform and Modernization Act

The Fed Oversight Reform and Modernization (FORM) Act

On Econbrowser, Carl Walsh critically discusses H.R. 3189, The Fed Oversight Reform and Modernization (FORM) Act. He points out that the output gap measure in a policy rule plays an important role.

He writes:

Legislating a rule for the Fed’s instrument as a means of constraining its discretion and holding it accountable for its policy actions represents a fundamental shift from a policy such as inflation targeting. Under inflation targeting, the central bank is held accountable for meeting a target that represents an ultimate goal of monetary policy – low inflation – rather than for moving its policy instrument consistent with a specific rule. …

Using an estimated DSGE model, I find that the optimal weights to place on goal-based inflation and rule-based Taylor rule performance measures depend importantly on the output measure employed in the rule. When the rule is similar to that proposed recently in U.S. H.R. 3189, I find the optimal weight to assign to the rule-based performance measure is always equal to zero – that is, the rule H.R. 3189 proposed would lead to inferior macroeconomic outcomes and should not be used.

This result is largely driven by the fact that the definition of output used in the legislated rule – output relative to trend – is not consistent with the definition of output the theory behind the model I use would imply – output relative to its efficient level. When the Taylor rule is modified to use the measure of economic activity that is more consistent with basic macro theory, outcomes can be improved by making deviations from such the rule a part of a system for accessing the Fed’s performance and promoting its accountability.