Clarity in communication from the Federal Open Market Committee makes policy more effective, but improvements can be made because the Great Recession caused the Fed to alter its behavior, making it difficult for markets to read how it will react to economic developments, according to Federal Reserve Bank of Cleveland President and Chief Executive Officer Loretta J. Mester.
"Independence in setting monetary policy is worth preserving because it yields more effective policy," Mester said in a speech in London Thursday, according to prepared text of her remarks, released by the Fed. "But accountability must go hand-in-hand with independence. A central bank cannot expect to remain independent from the political process unless it is transparent about the basis for its policy decisions. Because it takes time for monetary policy to affect the economy, the public won't be able to immediately see whether a policy action was a good one. So it is incumbent upon policymakers to explain the rationale for those decisions, including their evaluation of economic conditions as well as their outlook for the economy."
Mester wants the Fed to be "as clear as it can be that monetary policy will be contingent on the state of the economy."
In October, the FOMC statement noted that policy can change if the economy improves faster or slower than expected. Mester hailed the change. "I think this is an important message to convey to the public."
Another suggestion Mester offered, is the Fed should offer more information "about the conditions we systematically assess in calibrating the stance of policy to the economy's actual progress and anticipated progress toward our dual-mandate goals, and to the speed with which that progress is being made." She translated that as "how and why we came to our assessment" and how "progress toward our goals is pointing to a particular policy path."
Finally, Mester suggested the Fed help the public sort "signal versus noise in the data," since the amount of data available can be confusing. "What changes in the data and other economic information do we view as material enough to change our medium-run economic outlook or the risks around that outlook? Systematically providing the public with such information will allow people to anticipate how policy is likely to change in response to economic developments that affect the outlook," she said.
Discussing forward guidance, Mester said, it has been a tool during the recent extraordinary times, but when the situation is "more normal," forward guidance should let the public know how the Fed would react to changes in economic conditions. "In other words, in normal times, forward guidance will focus less on when policy will be changed or even the particular path of future policy, and more on the rationale for policy decisions."
The "FOMC's Summary of Economic Projections, with suitable amendments, could play a central role in helping the public better understand how U.S. monetary policy is likely to respond to economic developments."
First, the SEP "could link the variables across each participant's forecast so that the public could see what each policymaker is projecting for growth, unemployment, and inflation, and what policy path he or she believes will achieve those outcomes." She suggested this could be done without revealing individual identities.
The Fed could also "more plainly communicate the degree of uncertainty around the projections."
Also, Mester suggested, the Fed could offer more information about the consensus view. "After all, it is the consensus view that is reflected in the policy statement after FOMC meetings. Presenting more information on the consensus economic outlook that underlies the Committee's policy decisions would help clarify the statement."
