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Fed's Plosser Makes Case for Systematic Approach to Monetary Policy

WASHINGTON — Making the case for a systematic approach to monetary policy, Philadelphia Federal Reserve Bank President Charles Plosser said Tuesday the Fed's move to a threshold form of forward guidance was only a "step in the right direction," warning that it must be "humble" about the expected benefits of such guidance in the real imperfect world.

Referring to the policy-setting Federal Open Market Committee's recent statements, Plosser said, "Although my FOMC colleagues are not ready to choose a particular policy rule or reaction function to govern policy, we continue to explore the efficacy of monetary policy rules as guides to policy."

Plosser generally stressed the limits of monetary policy, which cannot "control or mitigate every shock to our economy," something the public should know.

In remarks prepared for delivery to the Stanford Institute for Economic Policy Research's Meeting in Stanford, California, Plosser did not comment on the Fed's current monetary policy or the economic outlook, which were initially expected to be the topic of his speech. Instead, the topic was switched to forward guidance using a rather academic approach.

Switching away from a guidance based on a calendar date, the FOMC vowed in December to keep short-term interest rates at exceptionally low levels so long as unemployment remains above the 6.5% threshold and inflation doesn't hit 2.5%

The move can be seen as an improvement in the Fed's transparency and communication, and "may help partially mitigate the risk of destabilizing inflation expectations," but it is still less efficient than a systematic approach, he said.

"Neither the calendar date nor the threshold form of forward guidance constitute the systematic approach to monetary policy that I prefer," Plosser said.

"While our models suggest that forward guidance is a useful policy tool, we must remain humble about its expected benefits in the real world of imperfect commitment, imperfect credibility, and difficult-to-manage expectations," he added.

In addition, for such forward guidance to be efficient in the current environment, where the Fed funds rate is nearly zero, the public must understand how the Fed intends to act in the future "and also that this conduct differs from the typical way policy is set."

"This required understanding underscores the usefulness of systematic policymaking not only at the zero bound but also in normal times," he said.

Instead, "The more clearly we can articulate a reaction function that serves us well in normal times, the more effective will be our forward guidance efforts at the zero bound and, for that matter, at other times when deviations from normal policy might be called for," he argued. "Thus, I have long been an advocate of systematic policymaking and increased transparency — in good times and in bad times."

"Adopting a rule can be an effective way of providing forward guidance, since it makes future policy actions more predictable," he said.

And predictability is good for present economic decisions, he added, something that also applies to fiscal policy.

"For example, it is my view that unclear expectations, or uncertainty, about the future course of federal tax rates and spending plans has had a significant dampening effect on the U.S. economy over the last two years," Plosser said.

Market News International is a real-time global news service for fixed-income and foreign exchange market professionals. See www.marketnews.com.

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