The minutes of the latest Federal Open Market Committee meeting, released last week, suggest the Federal Reserve is having some difficulty handling the transition to a new chairman.

Barring the unexpected, Ben Bernanke will succeed Alan Greenspan at the Fed’s top post. Bernanke already has gotten the nod from the Senate Banking Committee, and Majority Leader Bill Frist has pledged the Senate will confirm Bernanke “as one of its first actions” when it reconvenes. That would allow Bernanke to assume the chairmanship in time for Greenspan’s Jan. 31 retirement and to preside at the March 28 FOMC meeting.

So, what should he do at his first meeting? Imagine if you were taking over as a stepparent of a high-achieving teenager. Suppose the child was a straight A student, active in community service and a general joy to be around. Would your first move be to change all the rules set by your predecessor?

Saying vs. Doing

Obviously, the right thing to do is to come in and maintain the policies that are working so well. With Chairman Greenspan’s sterling reputation in mind, Bernanke has signaled to markets that this is exactly his plan.

“With respect to monetary policy, I will make continuity with the policies and policy strategies of the Greenspan Fed a top priority,” he said at his confirmation hearing Nov. 15.

Anyone can claim that; doing it is a different matter. The whole world will be watching Bernanke’s first meeting to see if his Fed will be different from Greenspan’s.

That first meeting needs to make as little news as possible. The best way to accomplish this is to do in the first meeting whatever was done in the previous one. That way, no dramatic departure would be evident.

The timing of Greenspan’s departure is unfortunate, however, and the current board seems to be managing the hand-off poorly.

The Fed has been steadily increasing the federal funds rate since June of 2004, to the current 4 percent from 1 percent. Last week, on Nov. 22, short-term interest rate futures jumped when the FOMC meeting minutes revealed some members expressed concern about the “risks of going too far in the tightening process,” raising the possibility the Fed may be nearing the end of its gradual increases phase.

Taylor Rule

It’s natural the Fed should be thinking about stopping. One reasonable guide for the federal funds rate is the “Taylor Rule” developed by Stanford economist John Taylor.

Taylor argued the Fed should set the federal funds rate based on the difference between desired and actual inflation and half of the difference between actual and potential gross domestic product. Taylor’s rule is a good rough barometer for where the federal funds rate should be.

Let’s pull out Economy.com’s trusty Taylor rule calculator. If the Fed thinks that inflation should be 2 percent, and that the economy is growing near potential when the unemployment rate is 5 percent, then the federal funds target should be 3.8 percent. Those are the numbers I would choose if I were at the Fed right now.

If the Fed instead thinks we’re growing faster, and that the natural rate of unemployment is 5.5 percent, then the federal funds target would be 4.6 percent. That higher rate would slow the economy, and increase unemployment to a less inflationary level.

Policy Change Expected

The truth may be somewhere between the two numbers, suggesting it would be fully sensible for the Fed to increase interest rates by 25 basis points twice more before Bernanke arrives, taking the rate to 4.5 percent.

But notice: If this happens, Bernanke’s first meeting will be different from Greenspan’s last. Greenspan will raise rates a quarter point; Bernanke will hold them steady.

The market is terribly confused about what will happen when Bernanke arrives. After last week’s release of the meeting minutes, the futures markets saw an 80 percent chance of a rate boost in January (bringing the federal funds rate to 4.5 percent) and a 66 percent chance of a pause in March.

The market expects a policy change on Bernanke’s arrival. How awful.

What to Do

So what should the Fed do to fix this problem? Following a loosely applied Taylor rule, policy makers might just let rates climb to 4.75 percent in March and be done with it. Their language and speeches between now and then could make such a plan clear. But there is a serious risk--mentioned in the minutes--that this monetary policy would be too tight.

With some economic data, such as unemployment claims, looking a tad iffy, here’s my solution: The Fed should increase rates 50 basis points in December, and then announce to the world that it’s done moving for a while.

That way the Fed will have a federal funds rate level that is pretty aggressive with respect to inflation. That is good for its credibility.

Greenspan can then have a quiet last meeting in January, and Bernanke can have a quiet one in March. That would be the perfect way to start the economy’s new relationship with the new Fed chairman.

Kevin A. Hassett is a resident scholar and the director of economic policy studies at AEI.