The Myth of the Explicit Reaction Function’s Necessity
Critics of Kevin Warsh’s new approach to monetary policy have fixed upon a strange idol: the reaction function.
The careful critics insist they are not demanding forward guidance. It’s just fine for the Fed to give up this heirloom of the financial crisis. They merely want the chairman to articulate the Fed’s “reaction function,” describing in detail how the central bank will adjust interest rates as inflation, unemployment, growth, and financial conditions change.
But this is largely a distinction without a difference. A promise tied to a date is calendar-based forward guidance. A promise tied to unemployment or inflation is...
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