Mester launches a rare call to the use of political rules as part of a broader Fed review

SAN FRANCISCO (Reuters) – The Federal Reserve should give policy rules "a bigger role" in its interest rate decisions, said Cleveland Federal Reserve Bank president Loretta Mester, a rare call from a current decision-maker to review US Central Bank operates.

In addition to more transparent economic projections, clear statements about how different economic variables affect interest rate decisions, and other improvements in Fed communications, Mester said the Fed could better understand to the population its monetary policy and its limits.

"While judgment is probably still part of policymaking, simple monetary policy rules can play a bigger role," she told a conference on monetary policy in New York. the Hoover Institution of Stanford University.

Mester said the Fed could choose "rules of thumb" and use them to explain to the public at every policy meeting why officials followed them or not. Instead of letting people guess what the Fed's "reaction function" is – how changes in economic data are changing policy choices – the central bank's choices might be more explicit.

"A more systematic approach to the definition of monetary policy can better align public expectations on policy decisions and help reduce some of the uncertainty" about the functioning of the Fed, Mester said.

Rules, mathematical formulas that use economic data as inputs and recommend a rate of interest, are a controversial topic at the Fed. They are consulted regularly, but officials are reluctant to use them as substitutes for their own judgment.

Mester's comments come as the Fed conducts a broad review of how it establishes monetary policy and communicates its decisions.

Mester said that since the economic crisis of 2007-2009, she felt that public expectations about what monetary policy could do, as well as her vision for the Fed, had been skewed by emergency efforts by the central bank to support the economy.

She fears that these efforts will leave many people feeling that the Fed is responsible for too many aspects of the economy's performance, even though its tools are only seen as effective in the short term. The Fed can not define "the true underlying structural aspects of the economy," Mester said.

In addition, she said many of the changes the Fed is considering would force the public to trust the central bankers to deliver on their political commitments.

She felt that this could be facilitated by the use of rules and other steps leading to the development of more "systematic" policies.