Let a Thousand Models Bloom: The Advantages of Making the FOMC a Truly 'Open Market'

Abstract In recent decades there has been a worldwide shift toward market-oriented economic policies, sometimes termed 'neoliberalism’. In the policy arena this trend has been most apparent in the widespread move toward privatization and deregulation. And in the academic world there has been increased respect shown to free market ideologies, even to policy views that would once have been regarded as impractical. Surprisingly, monetary policy is one area that has been relatively unaffected by the neoliberal revolution. Not only have governments retained a monopoly on fiat money, but even some free market ideologues have been skeptical of proposals for laissez-faire monetary regimes. This paper will show that market forces can greatly improve the effectiveness of monetary policy. I will argue that the Federal Open Market Committee (FOMC) should do no more than set the goals of monetary policy. Sumner (1989, 1995) and Dowd (1994) argued that the creative use of prediction markets for goal variables might allow central banks to more accurately target variables such as inflation. I will briefly review the literature on policy futures markets, examine Bernanke and Woodford’s (1997) critique of policies that “target the forecast”, and then suggest some improvements in previous reform proposals. More importantly, I show that policy future markets can address some of the key weaknesses of orthodox macroeconomic theory and policy, particularly the lack of consensus over structural models. Under this sort of policy regime, open market operations would reflect the views of not merely 12 individuals, but rather the consensus opinion of all those who choose to engage in open market operations. Even an issue as basic as the optimal monetary instrument would no longer be determined by the monetary authority, instead, each individual participant in the policymaking process would choose their own policy indicator. I will also show that a universal FOMC can improve the effectiveness of monetary policy even if the average level of decision-making skills on the expanded FOMC is inferior to the average skill level of the current 12 members.