The sub par performance of the U.S. economy extended into the first half of 2003. Although accommodative macroeconomic policies and continued robust productivity growth helped to sustain aggregate demand, businesses remained cautious about spending and hiring. All told, real gross domestic product continued to rise in the first half of the year but less quickly than the economy’s productive capacity was increasing, and margins of slack in labor and product markets thereby widened further. As a result, underlying inflation remained low.
(Fed Reserve Board, 2003)
In financial markets, longer-term interest rates fell, on net, over the first half of the year as the decline in inflation and the subdued performance of the economy led market participants to conclude that short-term interest rates would be lower than previously anticipated. These lower interest rates helped to sustain a rally in equity prices that had begun in mid-March. The Federal Reserve expects economic activity to strengthen later this year and in 2004, in part because of the accommodative stance of monetary policy and the broad-based improvement in financial conditions.
In addition, fiscal policy is likely to be stimulative as the provisions of the Jobs and Growth Tax Relief Reconciliation Act of 2003 go into effect and as defense spending continues to ramp up. Severe budgetary pressures are causing state and local governments to cut spending and to increase taxes and fees, but these actions should offset only a portion of the impetus from the federal sector. Moreover, the continued favorable performance of productivity growth should lift household and business incomes and thereby encourage capital spending. Given the ongoing gains in productivity and the existing margin of resource slack, aggregate demand could grow at a solid pace for some time before generating upward pressure on inflation.
At the heart of the current debate over just how the Fed should communicate the goals, strategy and conduct of monetary policy lies the issue of what central bankers call “transparency”: How much should the Fed say and to what end? However, in the interim, the debate has grown still more heated and confusing.
In my view, transparency is important not just to be accountable; it is essential for monetary policy to succeed. That’s because transparency about goals anchors inflation expectations, and understanding how the Fed operates makes financial market participants the Fed’s ally rather than its adversary. In short, transparency builds credibility. Thus, Fed officials should clearly state their goals, their resolve to achieve them and whether or not policy is in equilibrium. To be sure, transparency has its limits: To quote Fed Governor Edward Gramlich, “policymakers, of course, need to discuss various policy options in confidence. Doing otherwise will not get the most competent policymakers to the table, and it will not promote frank and open discussions.” (Fed Reserve Board, 2003) But that’s where the limits should end.
Give the Fed credit: Over the past two decades, Fed officials have dramatically improved their public communication of the goals of monetary policy. And they have articulated in far more detail than before how policy should be formulated and conducted. In my view, levaquin online uk clarity about both policy goals and framework and transparency about conduct has vastly improved the efficiency of policy. In an extremely important respect, the results have been wildly successful: Inflation and inflation expectations have been low and stable for a few years now, as the Fed’s commitment to price stability and getting market participants to share that goal have made it a reality.
For market participants, the process has been transforming. Only a decade ago, Fed watchers decoded signals from the Open Market Desk, and sometimes misread them. Today, the Fed is more inclined to let Fed watchers in on the conversation. Officials regularly and freely communicate their views about the economy and policy, so all market participants can weigh the risks surrounding policy choices on an ongoing basis. Announcing policy changes, the rationale for them, and how Members voted immediately following each meeting has helped all market participants understand policy intent. (Fed Reserve Board, 2003)
How should the Fed change its communiques to improve transparency? In my view, the Fed should spell out its goals so that we all know what range of inflation (or price level over time) constitutes price stability. Likewise, committing to an inflation goal will help eliminate confusion about how the Fed will react to unacceptably low inflation. And finally, stating a policy bias one way or another will reinforce understanding of where the Fed is going. Following these three precepts in my view will improve the Fed’s chance of success.
I’m not alone in that judgment. Inflation-targeting central banks such as the Bank of Canada (BoC) argue that “One of the most important benefits of a clear inflation target is its role in focusing expectations of future inflation…. it has helped to make the Bank’s monetary policy actions more readily understandable to financial markets and the public.” (BoC, 2003) But the Fed need not target inflation explicitly to reap the benefits of transparency about goals. For example, Fed Governor Ben Bernanke has merely specified what he thinks is an acceptable range for inflation (1% to 2% measured by the core chain-type price index for personal consumption) in order to clarify why the Fed today won’t respond to above-trend growth as in the past. (Fed Reserve Board, 2003)
Policymakers generally agree that monetary policy operates by shaping expectations – in financial markets and in the economy at large. Clarity about goals is the most critical ingredient in that process. But more straightforward disclosure would also help anchor expectations and get markets to help the Fed.
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