Thursday, August 10, 2006

Fed Policy and Commodity Prices

In an article for NRO, Thomas Nugent claims that the Federal Reserve uses a price rule to determine the course of the Federal Funds rate. This means that, as Nugent puts it "the Fed will supposedly track the price of a basket of commodities as a benchmark for inflation, and when the price of this benchmark moves above a certain level, the Fed will raise the fed funds rate (the price of money) until commodity prices move back within the target range."

He then goes on to claim that he did a study once upon a time that proved the Fed was indeed doing exactly this.

"In 1989, in an article for Laffer Associates (“The Price Rule Vindicated”), I tracked the implementation of the price rule relative to a proxy for the Fed’s benchmark, the Dow Jones Spot Commodity index, from 1982 through 1989. My conclusion was indeed that the Fed was conducting monetary policy using a price rule."

I think maybe Mr. Nugent needs to update his data because commodity prices have been anything but stable over the last several years. The Fed may have been using a price rule back in the 80s, but sometime over the last decade or so, it has been abandoned in favor of the Chairman Knows Best rule. Unfortunately, that rule seems a bit more flexible.

You can read the rest of Mr. Nugent's ode to central banks article here.

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