FRBSF Economic Letter
2006-01; January 27, 2006
2006: A Year of Transition at the Federal Reserve
This Economic Letter is adapted from remarks
by Janet L. Yellen, President and CEO of the Federal
Reserve Bank
of San Francisco, delivered to the Los Angeles Chapter
of the National Association of Business Economists in Los
Angeles on January 19, 2006.
At the end of this month, Alan Greenspan will bring to
a close his 18 years of distinguished service as Chairman
of the Board of Governors of the Federal Reserve System.
On February 1, Ben Bernanke will, in all likelihood,
have been confirmed by the Senate and will therefore be
in a
position to become the new Chairman. With such a significant
transition for the Fed just days away, this seemed like
a natural time to spend a few moments looking back at
the Greenspan Fed and offering some of my own views on
what
may lie ahead under a "Bernanke Fed."
The Greenspan years
 Alan Greenspan has won many plaudits for skillfully managing
monetary policy—and deservedly so. During the Greenspan
years, the U.S. economy has been extraordinarily stable,
with just two mild and short recessions (Figure 1), and
with low and stable inflation for over a decade (Figure
2). Clearly, in the short time I have today, I cannot do
justice to all the accomplishments, innovations, and successes
the Fed has achieved under his leadership. So I'll focus
on two aspects of policy that I believe have been especially
important to this sterling record—a systematic, and therefore
understandable and predictable approach to policy, and
a growing emphasis on communication and transparency.
I will focus first on what I mean by a systematic approach
to policy. While the Fed does not follow a policy rule,
it has been consistent in its approach to achieving its
dual mandate—keeping inflation low and stable and promoting
maximum sustainable employment. For example, when faced
with an unwelcome increase in inflation, the Fed has
consistently engineered a strong funds rate response. Indeed,
at times,
the Fed has taken preemptive measures, shooting inflation
before it "sees the whites of its eyes"; for
example, in 1994, it raised the funds rate aggressively
in response to indicators suggesting that demand had exceeded
capacity in labor and product markets, even though inflation
itself had not shown much of a rise. Likewise, when faced
with an unemployment rate that diverges from our best estimates
of so-called "full" employment, the Fed's response
also has been consistent and strong. Consider the start
of the 1990s, when the unemployment rate was rising—even
though inflation was some distance from price stability,
the Fed chose to ease policy.
 This systematic, consistent approach has enhanced the
ability of financial markets to anticipate the Fed's
response to
economic developments and to respond themselves in
advance of the Fed. Such market responses strengthen and
speed
the transmission of policy to the economy and conceivably
enhance economic stability. Moreover, such an approach
helps build the public's confidence in the Fed's commitment
to low and stable inflation; this, in turn, may well
make it easier for the Fed to respond to fluctuations
in labor
and product markets, because there is less risk that
an easing of policy will unleash a wave of inflation
fears.
As successful as this systematic approach has been, I
should note that it has by no means been a straitjacket
for policy during the Greenspan years. Rather, policy also
has been flexible when unusual circumstances called for
it. Let me give just one example. In the latter part of
the 1990s, the Greenspan Fed—and Greenspan in particular—was
quick to spot the productivity surge and to realize that
it meant that the unemployment rate could be significantly
lower than previously thought, for a time, at least, without
igniting inflation. This led to a policy of "forbearance," capturing
the benefits of lower unemployment while continuing to
move toward price stability.
Now let me turn to the second aspect of policy, namely,
the increased emphasis on communication and transparency.
One of the first steps in this direction occurred in
1994, when the FOMC first started issuing press releases
after
its meetings that explicitly announced changes in the
federal funds rate target. Over the decade or so since
then, the
press release has come to include a statement about the
balance of risks to the attainment of its dual mandate,
and at least some indication of where policy may go in
the future. This enhanced transparency works in tandem
with the systematic approach I discussed, because it,
too, helps the markets anticipate the Fed's response to
economic
developments.
A good example of this was the threat of outright deflation
in 2003. The FOMC wanted policy to err on the side
of accommodation until the threat had passed. With Japan's
unfortunate experience
in the 1990s as a clear object lesson, the Committee
believed that the costs of slipping into deflation
would
be worse
than the costs of a bit of overstimulation to economic
activity. This risk management approach to policy was
communicated to the public when the FOMC stated that, "In these
circumstances, the Committee believes that policy accommodation
can be maintained for a considerable period." This
forward-looking language itself seems to have helped
keep long-term interest rates low, thereby minimizing
the risk
of deflation.
Of course, there have certainly been other developments
in policy during the 18 years of Greenspan's chairmanship
that have contributed to its success in achieving
its dual mandate. But I believe these two—a systematic
approach to policy and more communication and transparency—are
particularly noteworthy. They have helped strengthen
public
confidence in the Fed and thereby helped anchor inflation
expectations to price stability.
Looking ahead
to the "Bernanke years"
These achievements provide a great foundation for the
new Chairman, Ben Bernanke. Having observed him when he
was a member of the Board of Governors from 2002 to 2005,
and being familiar with his remarkable body of research
on macroeconomic policy, I feel pretty confident that he
places an equally high value on a systematic approach as
well as on transparency and communication. Indeed, he has
stressed that clear communications about the central bank's
approach, its objectives, and its assessment of the economy
are necessary to reduce uncertainty and stabilize expectations.
And any of you who have read the speeches he gave while
he was a Governor will know that he is a consummate communicator
and teacher.
One area where he has differed with Chairman Greenspan
is on how to define "price stability." Of course,
both see price stability as a prime objective of policy.
But for Chairman Greenspan, the definition has been behavioral—that
is, he would say that we have achieved price stability
when inflation is low enough that it does not materially
affect people's economic decisions. In contrast, well
before Bernanke was nominated to be Fed Chairman, he
said that
he would like to see the establishment of a numerical
objective for price stability (see Bernanke 2003). Since
his nomination,
he has said that he would not institute such an approach
without a consensus among FOMC members.
For my part, I'm sympathetic to the idea of a quantitative
objective for price stability, as I agree that it enhances
both Fed transparency and accountability. I have previously
articulated my views on this. I see an inflation rate
between 1% and 2%, as measured by the core personal
consumption expenditures price index, as an appropriate
price stability
objective for the Fed. However, I also think it is
critically important that a numerical inflation objective
not weaken
our commitment to a dual mandate that includes full
employment. Therefore, I would see the numerical objective
as a long-run
goal and would want the Committee to have a flexible
timeframe
within which to maintain it. We've done a good job
under Chairman Greenspan of promoting both price stability
and full employment. I believe that a numerical long-run
objective
for inflation will enhance our ability to maintain
that
success even in the face of the significant challenges
that may come up.
Conclusion
Let me wrap things up by saying that I hope these brief
remarks have given you some appreciation of the remarkable
achievements of the Greenspan Fed over nearly two decades
and a glimpse into some issues that may arise in the "Bernanke
Fed." As a member of the FOMC, of course, I am going
to be "at the table," and in the thick of the
transition. It particularly pleases me to say that, with
the Fed's increased emphasis on communication and transparency,
you and the rest of the public are going to have a pretty
good view of how things play out yourselves. So stay tuned—I
think it's going to be a fascinating year for us all!
Janet L. Yellen
President and Chief Executive Officer
Reference
Bernanke, Ben S. 2003. Remarks at the 28th Annual Policy
Conference: "Inflation Targeting: Prospects and
Problems." Federal Reserve Bank of St. Louis, St.
Louis, Missouri (October 17).
Opinions expressed in this newsletter
do not necessarily reflect the views of the management
of the Federal Reserve Bank of San Francisco or of the
Board of Governors of the Federal Reserve System. Comments?
Questions? Contact
us via e-mail or write us at:
Research Department
Federal Reserve Bank of San Francisco
P.O. Box 7702
San Francisco, CA 94120
|
