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President's Speech
Presentation to the Bank of Japan’s 12th International
Conference
of the Institute for Monetary and Economic Studies
(Tokyo, Japan)
by Janet L. Yellen, President and CEO of the Federal Reserve Bank of
San Francisco
For delivery May 31, 2005, 2 P.M. Tokyo, Japan, 10 P.M. (May 30)
Pacific
Daylight Time,
1 A.M. (May 31) Eastern
Policymaking on the Federal Open Market Committee (FOMC):
Transparency and Continuity
It is a pleasure to take part in this conference. I thank the Bank
of Japan for inviting me to share my views on incentive problems in monetary
policy committees at central banks.
I thought I would organize my remarks around two issues discussed in
the paper by Fujiki (2005) and in the sessions—transparency and
continuity—and do so in the context of two recent issues confronting
the Federal Open Market Committee (FOMC): (1) its recent decision to
expedite the release of the minutes of its meetings; and (2) its recent
discussion regarding the adoption of a numerical definition of price
stability.
Over the past decade, the FOMC has continually re-assessed the costs
and benefits of various steps toward greater transparency and has
made several significant increases in policy communication and openness.
In February 1994, just months before I became a Federal Reserve Governor,
the FOMC started to explicitly announce changes in the federal funds
rate target. Later that year, the FOMC added descriptions of the
state
of the economy and the rationale for the policy action to the post-meeting
press release. In January 2000, the FOMC introduced a statement describing
the “balance of risks” to the outlook, and in March 2002
began releasing the votes of individual Committee members and the
preferred policy choices of any dissenters. In August 2003, the Committee
added
explicit forward-looking language concerning future policy into its
statement. Finally, in December 2004, it decided to release the minutes
of its meetings
with only a three-week delay. Previously, the minutes were made public
with a five- to eight-week lag, just after the subsequent meeting
and were, hence, less relevant to policy.
This decision to speed up the release of the minutes occurred several
months after I returned to the FOMC table as President of the Federal
Reserve Bank of San Francisco. I think it illustrates some of the
important issues relating to transparency in monetary policy committees.
In considering whether to expedite the release of the minutes,
potential costs were certainly recognized. Financial markets
could misinterpret
and overreact to the minutes. Greater emphasis on the minutes
might also lead to less productive discussions at the meetings, because
even speculative
and off-the-cuff commentary would soon be out in the open and,
hence, discouraged. On the benefit side, however, expedited release
of the
FOMC minutes provides more timely information to the public about
the rationale
for monetary policy actions and a more nuanced explanation of
the
reasons for the Committee’s decisions. Such a move toward
greater transparency facilitates accountability, which is essential
for unelected central
bankers in a democratic society, and might make monetary policy
more effective by helping to align financial market expectations
with policy
objectives.1
One impact of expedited release of the minutes is that it results
in the earlier airing of differences of opinion among members.
A more
subtle issue is whether the exposure of such differences might
affect the degree
of collegiality in the Committee. This issue is important because,
in my view, cooperation is critical to the FOMC’s success.
My sense is that FOMC participants are highly motivated to
cooperate in seeking,
finding, and articulating a Committee consensus, and their
ability to do so enhances the credibility, legitimacy, and
likely effectiveness
of monetary policy. In fact, I think FOMC members behave far
less individualistically
and strategically than assumed in some of the models summarized
in Fujiki (2005). I do not find this terribly surprising. Sociologists
find that
in group situations, individuals are typically motivated to
build on common ground to resolve differences of opinion and
attain agreement.2 Without
such a sense of group solidarity, a 19-member committee like
the FOMC could find it so time-consuming
as to be practically
infeasible
to craft even a short, post-meeting statement commanding majority
agreement. Such sociological reasoning might also explain why
FOMC dissents are
so rare.
The jury is still out on whether the earlier exposure of differences
of opinion will affect the sense of collegiality in the FOMC.
Earlier release of the minutes affords greater flexibility
for members
to express their personal views publicly, for example, in
speeches, without
creating
undue market confusion. My guess is that this will make it
easier, not harder, to attain consensus, but time will tell.
A second issue relating to communication and transparency
that the FOMC discussed in February 2005 is whether to adopt
an
explicit, numerical price-related objective for monetary
policy. The Committee
decided
to
hold off for now, but I am sure that, along with other issues
in monetary policy communication, this topic will be on the
table again
in the
future.
The Federal Reserve Act gives the FOMC a dual mandate—to pursue
maximum sustainable employment and price stability—but
does not define either objective. My personal view is that
the quantification
of the long-run price-stability objective could offer several
benefits. In terms of Committee operations, it could help
to focus and clarify
our own discussions. It could also help to anchor the public's
long-term inflation expectations from being pushed too far
up or down. That is,
a numerical long-run inflation objective may help avoid both
destabilizing inflation scares and pernicious price deflations.
Indeed, a credible
inflation objective could enhance the flexibility of monetary
policy to respond to the real effects of adverse shocks.
As with any move toward greater transparency, there are potential
drawbacks. A main concern is the possibility that the enunciation
of an inflation
objective will be perceived as or result in a downweighting
of the Committee’s
maximum employment mandate. To guard against miscommunication,
the nature of this objective would have to be very clearly
stated as a long-run
goal only, with the path for attaining it dependent on the
implications for other Fed objectives, especially employment
and financial stability.
The adoption of an inflation objective also raises issues
related to the continuity of FOMC behavior. The price stability
mandate
is overarching
because it is included in the Federal Reserve Act. But the
interpretation of that mandate is left up to the Committee.
Since one FOMC cannot
bind future FOMCs, the potential for discontinuity could
be large if individual
views on the appropriate numerical objective were to change
significantly over time or as a result of changes in the
membership.
With respect to the likely stability of individual views
over time, the evolution of my own thinking on this topic
is perhaps
instructive.
When
I was a Federal Reserve Governor, the FOMC discussed a numerical
objective for inflation at its July 1996 meeting. At that
meeting, there was
some consensus among the participants, including myself,
for a 2 percent long-run
objective for consumer price index (CPI) inflation. From
an economic standpoint, I believe the choice of an inflation
objective
should
depend on an evaluation of the costs and benefits of very
low inflation. Since
then, there have been several important economic developments
relevant to this choice. I argued in 1996 that the inflation
objective should
contain a cushion sufficient to grease the wheels of the
labor market. The potential negative impact of downward nominal
wage
rigidity on
real economic performance diminishes, however, with productivity
growth, which
raises average wage growth. As it turns out, high productivity
growth in the U.S. during the past decade has made downward
wage rigidity
a non-issue, suggesting that a lower inflation buffer is
sufficient. But,
for me, this shift has been offset by the experience of very
low inflation in the U.S. and deflation here in Japan, which
has heightened
my concern
relating to the zero lower bound on the policy interest rate.
Other relevant economic factors include the magnitude of
the neutral
real funds rate,
the degree of macroeconomic volatility, and methodological
changes affecting measurement biases.
Taking all of these factors into account, I find myself still
pretty comfortable with the numerical objective I had recommended
almost
a decade ago. More specifically,
I would now favor a 1.5 percent numerical objective for inflation
as measured using the core personal consumption expenditures
(PCE)
price index, which,
given the recent average differences in measurement bias,
corresponds to a 2 percent
objective for the core CPI. If the stability of my own views on the
appropriate numerical inflation objective is representative,
it seems likely that
the FOMC’s
numerical inflation objective would probably change fairly little
over time due to economic factors.
The numerical inflation objective could also potentially evolve with
changes in the membership of the FOMC, assuming some divergence
in views among
members. In fact, however, a number of Committee members have individually
opined
on this topic and the actual differences of opinion turn out to
be rather small.
I would
characterize a long-run inflation objective centered on 1.5 percent
for core PCE inflation as a “modal” view. Even if there were more significant
differences of opinion, an advantage of a monetary policy committee is that a
slow, continuous transition of new members is apt to produce greater continuity
than might occur with a single central banker, where the replacement of the Governor
could result in discrete policy shifts. In addition, the “sociological” considerations
I discussed earlier, which foster cooperation and consensus, could encourage
new members to support the goals endorsed by the prior committee. In practice,
then, I think there would be ample continuity in the FOMC’s
inflation target.
Continuity is an especially important issue facing
the FOMC now,
as Chairman Greenspan’s term as a Federal Reserve Governor comes to an end. The Chairman
changes infrequently—we have had only two in the past quarter-century.
But one of the strengths of the FOMC is the broad experience
of its members and staff. During the transition to a new Chairman,
this should help ensure continuity.
To conclude, I would like to stress that there are no final answers,
and that transparency and continuity are important issues which
we face on the FOMC
at almost every
meeting.
1 Swanson, Eric.
2004. “Federal
Reserve Transparency and Financial Market Forecasts of Short-Term
Interest Rates.” Finance and Economics
Discussion Paper No. 2004-6. Board of Governors of the Federal
Reserve System.
2 Haslam, S. Alexander.
2004. Psychology in Organizations: The Social Identity Approach. 2d
ed. London: Sage Publications.
Fujiki, Hiroshi. 2005. “The Monetary Policy Committee and the
Incentive Problem: A Selective Survey.” Forthcoming in Monetary
and Economic Studies, 23 (S-1). Institute for Monetary and Economic
Studies, Bank of Japan.
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