Tools and Objectives

It's easy to frame it the other way: 'short term interest rates are the central bank's main tool for pushing the economy in the right direction'. Anyway, scotts point is correct, thinking about monetary policy in terms of interest rates is a terrible practice.

Funny. Your post is almost something Scott would have written.

What Scott should have said (meant to have said) was: "Because central banks are used to *thinking of* short term rates as their primary tool, policy may well become sub-optimal when rates hit zero".

And central banks, indeed the whole Neo-Wicksellian macroeconomic orthodoxy, most certainly do think of short term interest rates as the policy tool. They find it very hard to think about monetary policy in any other way. They find it hard to communicate monetary policy in any other way. Yep, it is a category error. That, basically, is what Scott himself keeps saying.

Well, I think it'd be fair to say that when the Fed board meets, the room is full of tools.

That said, I see your point, but at the same time disagree. Interest rates are both a tool and an object. The economy is a complex system, and interest rates are one factor in its behavior. The Fed sets interest rates (i.e. they're an object), but the level of interest rates is then a tool to effect change on the rest of the system.

But interest rates can't be an objective. An interest rate target alone leaves the inflation rate indeterminate. The Fed's mandate specifies price level and unemployment. If they let either get out of control, they would be chastised by Congress, even if they perfectly hit their interest rate target. Interest rates are neither an objective nor a tool. They are a strange way of communicating a monetary policy stance.

The screw that attaches the handle to the pot has only instrumental value; it is not a “tool,” because ordinarily it carries out its function without any manipulation by us. The screwdriver, which also has only instrumental value, *is* a tool because it must be manipulated by us in order that our purpose be achieved. The immediate purpose (objective) is getting the screw to do what we want it to do; this objective is itself a means to a further objective, and so on. Ultimately, as they say, we must arrive (conceptually) at a final objective, which (we think) has not merely instrumental but *final* value. (I believe Aristotle was the first to make this point.)

Whatever the Fed’s objective—supposedly, price-stability-cum-full-employment—it tries to achieve this objective by manipulating the Fed Funds rate; the Fed Funds rate is, precisely, a *tool* that the Fed is using. (Here we need not concern ourselves with what the *final* goal is; it probably is not price-stability-cum-full-employment, but something grander.)

In order to manipulate this tool, the Fed uses open market operations—something like a further “tool,” though it sounds unnatural to say that open market operations “manipulate” anything. It is as if, in order the better to grip the screwdriver, you put on a rubber glove. The glove is something like a “tool,” used to facilitate the manipulation of the screwdriver. Open market operations are something like a “tool,” used to accomplish the manipulation of the Fed Funds rate.

I see no error in Sumner’s remark.

Several commenters seem to be forgetting that the Fed doesn't set interest rates, it influences them through open market operations. This is why they are not the tool.

Well, the screw is both an object and a tool. It's part of the pot, which is a cooking tool.

I think a much better analogy would be open market operations being setting the height of the flame on the stove and interest rates being the temperature of the water in the pot.

I got sloppy. I meant to say using the fed funds target as a policy tool. The Fed controls the fed funds target directly, they influence the fed funds rate via open market operations.

It seems a minor semantic niggle at worst. Merriam Webster defines "tool" in multiple ways, including "something (as an instrument or apparatus) used in performing an operation . . . " or as "a means to an end."