cato-journal-v34n2

Cato Journalreinforces the independence of monetary policymaking, which leadsto better economic outcomes.Implementing Policy and Limiting DiscretionSuch independence in a democracy also necessitates that the centralbank remain accountable. Its activities also need to be constrainedin a manner that limits its discretionary authority. As I havealready argued, a narrow mandate is an important limiting factor onan expansionist view of the role and scope of monetary policy.What other sorts of constraints are appropriate on the activities ofcentral banks? I believe that monetary policy and fiscal policy shouldhave clear boundaries (Plosser 2009, 2012). Independence is whatCongress can and should grant the Fed, but, in exchange for suchindependence, the central bank should be constrained from conductingfiscal policy. As I have already mentioned, the Fed has venturedinto the realm of fiscal policy by its purchase programs of assets thattarget specific industries and individual firms. One way to circumscribethe range of activities a central bank can undertake is to limitthe assets it can buy and hold.In its System Open Market Account, the Fed is allowed to holdonly U.S. government securities and securities that are direct obligationsof or fully guaranteed by agencies of the United States. Butthese restrictions still allowed the Fed to purchase large amounts ofagency mortgage-backed securities in its effort to boost the housingsector. My preference would be to limit Fed purchases to Treasurysecurities and return the Fed’s balance sheet to an all-Treasury portfolio.This would limit the ability of the Fed to engage in credit policiesthat target specific industries. As I’ve already noted, suchprograms to allocate credit rightfully belong in the realm of the fiscalauthorities—not the central bank.A third way to constrain central bank actions is to direct the monetaryauthority to conduct policy in a systematic, rule-like manner(Plosser 2008, Kydland and Prescott 1977). It is often difficult forpolicymakers to choose a systematic rule-like approach that would tietheir hands and thus limit their discretionary authority. Yet, researchhas discussed the benefits of rule-like behavior for some time. Rulesare transparent and therefore allow for simpler and more effectivecommunication of policy decisions. Moreover, a large body ofresearch emphasizes the important role expectations play in206