Orphanides aims at putting the Federal Reserve monetary policy in a historical perspective. Looking at times of earlier recessions and the following liftoffs in 1983, 1994 and 2004, he points out that the liftoffs – that is the process of policy normalization after the end of a recession – usually ranged from within a year to within three years from the end of a recession. Based on these experiences the liftoff seems overdue after the latest recession, which was associated with a very large increase in the unemployment rate.
For Orphanides one major problem is the twofold mandate of the Fed trying to achieve “maximum employment” and “stable prices” at the same time. “The temptation to explore the limits of maximum employment invites harmful discretion,” he writes. The focus on reducing unemployment is creating fear of liftoff after recessions. By trying to push the unemployment rate too hard, the Fed generates a future cost, he points out.
According to Orphanides the central bank should eschew discretion in favor of a transparent policy rule. “The publication of a simple rule by the Federal Reserve would solve the monetary policy quandary”, Orphanides concludes. The Federal Reserve should select and develop a simple rule that “reflects the present state of knowledge and is robust to error”. At the same time, it could “retain the discretionary authority for periodic review and adaption of its rule, using the expertise available in the Federal Reserve System”.
IMFS Working Paper No. 95
"Fear of Liftoff: Uncertainty, Rules and Discretion in Monetary Policy Normalization"
(PDF, 522 KB)