NEW YORK – Monetary policy should be set by a series of well-crafted rules, Federal Reserve Bank of Philadelphia President and Chief Executive Officer Charles I. Plosser said today.
“I am in favor of a systematic, rule-based approach to monetary policy, primarily because it limits discretion and improves economic stability by reducing policy uncertainty,” Plosser told the European Banking & Financial Forum, according to prepared text of his remarks, which were released by the Fed. “But I will argue that choosing the particular form of the rule must be done with great care, because many of the economic variables that could be used in setting policy are in fact poorly measured.”
He added, “simple” rules would be a benchmark to force “policymakers to be more systematic and less discretionary in their approach to policy.” Such a system, he said, would mean more economic stability and lower inflation since it would be clear when policy deviates from the norm. “When such deviations occur, policymakers would need to communicate the reason,” he said.
Three problems arise if an output gap or an unemployment gap is used. “Basing policy on such an ill-measured variable has led to policy errors in the past and could do so in the future as well. In my view, policy should respond aggressively to movements in inflation from a target, and if it responds to economic activity, it should respond to measures of economic growth rather than an output gap,” Plosser said.
“This approach has important implications in the current environment as various economies around the world begin to recover from the global financial crisis and the Great Recession. Although there is a good deal of uncertainty about the pace of those recoveries, as the expansions continue, central banks will eventually need to tighten monetary conditions. My remarks today are intended to highlight that statistical measures of output gaps or unemployment gaps could very well appear to remain quite wide, even when increases in economic growth and the outlook for inflation call for such tightening. Explaining such decisions about the appropriate stance of monetary policy will be challenging, and central bankers will need to communicate with the public about these issues well in advance of their decisions to ensure that their policy actions are not misunderstood,” he said.
