Market expectations have swung sharply leading up to the Federal Reserve’s rate-setting meeting this week. With conflicting signals sent by Federal Open Market Committee members, traders moved back and forth between expecting the Fed to hold rates steady and anticipating a quarter-point increase. But following a positive jobs report and elevated inflation reading for August, CME FedWatch odds have moved firmly toward a rate hike.
The monetary policy rules have been much less volatile.
The Monetary Rules Report from AIER’s Sound Money Project puts the appropriate federal funds rate somewhere between 3.79 and 6.02 percent. A quarter-point increase would lift the Fed’s target range from 3.50–3.75 percent to 3.75–4.00 percent, bringing policy back into the lower end of the range prescribed by the leading rules.
That would also provide an early test of the monetary policy philosophy Chair Kevin Warsh laid out last month.
A Discipline, Not a Decision
Warsh used his recent Jackson Hole speech to criticize the Fed’s reliance on forward guidance. By making “quasi-commitments” to future interest rate decisions, he argued that policymakers unnecessarily constrain their own freedom to respond to changing economic conditions. Warsh also called for the Fed to develop “more reliable models and more robust rules to guide policy decisions.” He concluded by saying that he was committed to “a discipline, not to a decision.”
This is a timely comment, as the monetary rules contrast with a lack of discipline at the previous few FOMC decisions. Holding steady in April was reasonable. The target for the federal funds rate was in line with the lower end of the range prescribed by the monetary rules, and there was significant uncertainty around the relatively new conflict in the Middle East. Since June, however, the rules have clearly signaled that policy is too accommodative given prevailing economic conditions.
The September meeting offers an opportunity to move policy back toward a more disciplined, rules-guided approach.
A rules-based approach does not mean that the federal funds rate is set mechanically or that monetary policy is put on autopilot. A formula cannot capture every relevant feature of the economy, and policymakers will naturally be tempted to exercise their own subjective judgment. The advantage of a rules-based approach is that it limits the errors that can arise from poor judgment. Following the guidance of monetary rules and publicly explaining deviations when they arise would help stabilize the public’s expectations and prevent the most damaging policy errors. A rules-based approach is a direct path to a more disciplined monetary policy.
What the Rules Say
The Taylor Rule is the most familiar monetary rule. It recommends a higher interest rate when inflation is above target and a lower rate when economic activity falls below its sustainable level. Using the latest available data, the original Taylor Rule points to a federal funds rate of 6.02 percent. A modified version that smooths interest-rate changes and incorporates forecasts of future inflation produces a much lower prescription of 3.79 percent. A quarter-point hike at the upcoming meeting would move the target range to 3.75-4.00 percent, putting it squarely in line with the latter.
Rules based on nominal GDP, or total dollar spending in the economy, also point above the current target range. An NGDP growth rule prescribes 5.38 percent, while an NGDP level rule prescribes 4.10 percent. The growth rule is particularly telling, as the latest estimate from the BEA puts NGDP growth at 8 percent for the second quarter of 2026 — double what would be expected if the Fed were hitting its 2 percent inflation target. The exact estimates differ, but the general message from the NGDP rules has been consistent since June: monetary policy remains too accommodative given the pace of spending across the economy.
Over the past few months, the monetary rules have consistently suggested that policy needs to become more restrictive. This stands in contrast to how volatile market expectations of the September decision have been.
The probability of standing pat or hiking has swung dramatically in response to incoming data, geopolitical developments, and comments from Fed officials. That volatility may reflect concerns that the Fed is basing policy on considerations beyond its dual mandate of price stability and maximum employment – namely, fiscal and political pressures. The fact that the monetary rules look through these considerations is one of the strengths of a rules-based framework. They have not displayed a similar level of volatility because they are tied to the broader economic fundamentals. If the Fed begins relying more heavily on “robust rules to guide policy decisions,” greater stability and predictability would be one of the benefits.
An Early Test for the Warsh Fed
Warsh also argued at Jackson Hole that policymakers should focus on economic trends rather than overreacting to individual data points. On inflation, he set a high standard: the Fed should be confident that underlying inflation is returning to 2 percent “clearly and at sufficient speed.” Otherwise, he said, “we have work to do.”
The latest rule estimates suggest that there is more work to do. Inflation remains elevated, nominal spending remains strong, and Warsh himself has acknowledged that he would be “hard pressed to describe broad financial conditions as restrictive.” A quarter-point increase this month would therefore be consistent with both the monetary rules and the framework Warsh outlined at Jackson Hole.
If the FOMC instead leaves rates unchanged, the public will be looking to understand why. A more disciplined Fed should be able to explain itself. Perhaps Fed officials believe there is a good argument for keeping the target range below the prescriptions of the leading rules. Officials can make that argument without issuing unnecessary forward guidance, and doing so would help instill the discipline that Warsh has committed to.
Warsh is right that good monetary policy requires “a discipline, not a decision.” The September meeting will begin to show what that discipline looks like in practice.
