FRBSF Economic Letter
2005-22; September 2, 2005
Policymaking on the FOMC: Transparency and Continuity
This Economic Letter is
adapted from remarks by Janet L. Yellen, President and
CEO of the
Federal Reserve Bank
of San Francisco, delivered at the Twelfth International
Conference, "Incentive Mechanisms for Economic Policymakers," at
the Institute for Monetary and Economic Studies at the
Bank of Japan in Tokyo on May 31, 2005.
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 issues
the Federal Open Market Committee (FOMC) recently took
up: (1) its decision to expedite the release of the minutes
of its meetings; and (2) its discussion regarding the
adoption of a numerical definition of price stability.
The Fed's
recent steps towards transparency
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 (see Swanson 2004).
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 (see
Haslam
2004). 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. Another
step: quantifying a long-run price-stability objective?
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. Continuity
and the explicit, quantified price-stability objective
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% 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 faster 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% 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% 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% 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 we face on the FOMC at almost
every meeting. Janet L. Yellen
President and Chief Executive Officer References
[URL accessed August 2005.]
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.
Haslam,
S. Alexander. 2004. Psychology in Organizations:
The Social Identity Approach. 2nd ed. London: Sage Publications.
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. http://www.federalreserve.gov/pubs/feds/2004/200406/200406pap.pdf
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