Central banking is more than tinkering with interest rates

How often should central banks have their Monetary Policy Committee, or equivalent, meetings to decide upon the policy rate?

As the annual Jackson Hole Wyoming conference of central bankers is underway, all ears will be geared to the statements of the Federal Reserve Chair Jerome Powell. As usual, every phrase and sentence that he utters will be parsed by bond and equity traders to assess what the Fed will do in its upcoming mid-September meeting.

Despite falling inflation, there is deep discontent among the public about high prices for food. Democratic Presidential candidate Kamala Harris has stated that she will push for legislation to control price gouging.  Further, unless conflict between Russia and Ukraine and Israel and Iran deescalates, the risk of an oil price spike looms in the background. Nevertheless, the weak jobs report for July, signalling recession by the Sahm rule, coupled with just reported big downward revisions to job growth, along with headline inflation falling below 3 percent for the first time since April 2021, all put together strongly suggest a rate cut in September. The big uncertainty seems to be only whether it will be 25 or 50 basis points.

Against this backdrop, it is worthwhile to ask a very different question that, it seems to me, is not raised in discussions of monetary policy.

How often should central banks have their Monetary Policy Committee, or equivalent, meetings to decide upon the policy rate and/or related choices such as the Cash Reserve Ratio?

As of now, the Federal Reserve, the European Central Bank, the Bank of Japan, the Bank of Canada, the Bank of England, the Bank of Korea, the Banco de Brazil, and since this year the Reserve Bank of Australia all meet eight times a year.  The Reserve Bank of India and the South African Reserve Bank meet six times and the People’s Bank of China (PBOC) four times a year.  The most common frequency is eight, following the Fed’s practice for decades.

Going beyond facts, the policy question is whether more frequent meetings are good or bad for macroeconomic outcomes. The obvious benefit of more frequent meetings is that they make it more feasible to take the latest data and events into account in setting rates. The potential drawback is that they may make the central bank’s policy makers more prone to tinker excessively with rates, since every meeting provides an easy chance to do so. As a result, such tinkering or fine tuning may inadvertently end up destabilising it.

To what extent there is such tinkering can be easily assessed by simply comparing the number of rate changes with the number of meetings per year. Let us consider the five-and-a-half-year period starting 2019 to present for the Fed and the PBOC.  There were 16 changes in all, averaging about three per year.

Only in 2023 did the Fed change rates very often, seven times.  That was its frantic response to a huge inflation surge. That inflation surge was partly a result of the Fed’s excessive laxity of a 0 to 0.25 percent target rate for two years after Covid-19 hit in early 2020. Leaving out 2023, there were about two changes per year, amounting to a change once in four meetings.

The PBOC meets half as often -- four times a year. For this chosen period it has changed rates eleven times in all -- either thrice, twice or once in each of these years, averaging about twice a year. It moves in smaller increments than the Fed’s standard 25 basis points or multiples thereof. Ten basis points changes is quite common for the PBOC, although five and often twenty point changes also have been made fairly often.

The factual takeaway is that having eight scheduled meetings per year has not led the Fed to try and fine tune. And although the PBOC can risk more changes since its moves are smaller, its changes have also been fewer than its four meetings per year.

Thus frequent meetings have not led to potentially damaging fine tuning for both.  Further they also provide an easy option of quick response when needed, instead of having an emergency unscheduled meeting. That being the case, why not just continue with eight meetings per year as the Fed and most central banks now do?

However, there is a good reason for meeting less often.  Every scheduled meeting is a time sponge for the Bank’s staff, who laboriously spend enormous time in preparing projections and presentations based on the latest data. These tend to become irrelevant a few days or weeks later when the next month’s incoming data may point in another direction.

In my opinion, the main benefit of fewer rate setting meetings is that it frees up the central bank to reallocate more of its staff and their work towards other neglected, vital functions – specifically regulation and supervision of the banking and financial system. Central bankers nowadays spend a good deal of their time poring over monthly data, preparing for the FOMC type meeting, trying to comprehend the difference between “trimmed mean” versus  “supercore” measures of inflation.  Hence they are less able to keep tabs on more important issues they need to regulate: earnings, NPAs and various other activities of commercial banks, apart from managing cyber security risks, crypto currencies and keeping abreast of developments in fintech and blockchain.

With a maximum of say four meetings per year, the central banks could look at quarterly inflation, ignoring any monthly zigzags.  Exigencies will arise. But an emergency meeting can always be held to change rates, as the Fed did in early 2020 just after Covid-19 hit. With fewer meetings, the financial market traders who keep making and revising their projections would have less scope to bet on the next rate cut.  Fewer meetings would lead to less trading and related activity.  That would definitely not benefit Wall Street.  Other central banks would follow suit, and that would be globally good as well.

Donald Trump won in 2016 riding a wave of righteous resentment on umpteen issues. One issue was the Fed’s damaging actions that triggered the global financial crisis. His ardent supporter Vivek Ramaswamy has repeatedly attacked the Fed and even dismissed the Phillips curve as irrelevant. Some of his statements are plain erroneous.

Kamala Harris’ proposed policies to curb food price gouging are more likely to hurt not help consumers.  But instead if she makes it part of her campaign plank to reduce the number of FOMC meetings to four per year, that would be signalling her commitment to placing Main Street above Wall Street, but without risking loony libertarian anti Fed policies, and that Trump talks about. That should even garner her some votes.