Must-Read: Miles Kimball: Larry Summers: The Fed Looks Set to Make a Mistake
Live from Jackson Hole 2015 Weblogging: Must-Read: I think Miles Kimball is dead-on here: unless the advocates of interest-rate smoothing can come up with an argument for interest rate smoothing better than any they have so far, the right level of the Federal Reserve’s short-term federal funds control rate is (if it is away from its zero lower bound) the level at which the Fed is uncertain whether its move at the next meeting will be up, down, or zero:
: Larry Summers: The Fed Looks Set to Make a Mistake: “Let me address one myth…
…that Mike Woodford has shown that interest-rate smoothing makes sense. I would be glad to be corrected, but I think this myth arises because Mike talked about the Fed carrying about affecting… expectations of future rates. Just as backward-looking state variables have forward-looking costate variables, bond market expectations are like a forward-looking state variable for the Fed; those bond market expectations have a corresponding backward-looking costate variable…. Such backward-looking costate variables giving guidance about doing the right thing in relation to bond-market expectations contribute additional drift terms to the optimal policy rate, but it still seems to me that over a six-week span of time between FOMC meetings, the variance of news is sufficient that the effect of news should typically be substantially larger than the sum of all drift terms on the policy rate. Hence the metaphor of a muddy random walk.