NEW YORK – While the Federal Reserve has made “significant” progress in promoting transparency, it can go further, Federal Reserve Bank of Philadelphia President and Chief Executive Officer Charles I. Plosser said Wednesday.
“We can and should provide more details about the interplay between economic conditions and policy,” Plosser told the Forecasters Club in New York City, according to prepared text of his speech, released by the Fed. “We can also better define our reaction function, to enable the public to better understand and anticipate future policy actions.”
The impetus for increasing transparency, he said, is that studies indicated it “can improve the effectiveness of monetary policy, as well as the Fed’s accountability with the public. These benefits underscore the importance of our continued pursuit of finding better ways to communicate our framework for monetary policy decisions.”
Plosser said “there are four interrelated dimensions to a stronger monetary policy framework.” First the Fed needs to commit “to a set of clearly articulated objectives that can be feasibly achieved by monetary policy.” Then, it must “be transparent and clear in its communications.” Also, the Fed needs “to conduct monetary policy in a systematic or rule-like manner.” Finally “and arguably the most important,” monetary policy has to be set independent of fiscal authorities.
A subcommittee was empowered last year to “develop recommendations to improve the Federal Open Market Committee’s communications.”
The FOMC, in January, adopted two of the panel’s initiatives: issuing a consensus statement of principles about its long-run policy goals and objectives; and the releasing of the expected policy path of each member of the committee.
The consensus statement helps clarify policy in four ways: it reaffirms the Committee’s commitment to its mandate to promote “maximum employment, stable prices and moderate long-term interest rates”; it stresses that inflation over the longer run is mainly determined by monetary policy; an explicit numerical goal is not appropriate for maximum employment; and price stability and maximum employment are complementary, he said.
Plosser noted, the projections for the policy path “isn’t necessarily the most likely path; instead, it is the path viewed as being the best policy. Thus, the projections should not be compared with the forecasts of private-sector forecasters who try to predict what the Fed’s next move might be. Instead, each policymaker makes economic projections based on an assessment of the best policy path to achieve the most desirable outcomes.”
The improvements Plosser would like to see includes providing “more information about the linkages among the economic variables and the associated policy paths.” He would also like the Summary of Economic Projections “to include a matrix of output, inflation, and unemployment, and the associated policy path assumptions that each policymaker submitted. This would make the information in the SEP easier to interpret and give a better sense of the linkage between changes in economic conditions and policy.”
Also, Plosser believes the Fed should offer “a more comprehensive monetary policy report four times a year” instead of twice and that the FOMC “should adopt clearer guidelines on how policy evolves with economic conditions.”
“Of course, policymakers do not know with any degree of certainty how economic conditions will evolve,” he warned, “so they cannot and should not say with any certainty what policy will be in the future. But policymakers can provide information about the factors that will influence their policy decisions.”
The public, he said, needs more information about the Fed’s reaction function. “The practice of using systematic rules as guides to monetary policy imposes an important discipline on policymaking and improves communication and transparency,” he said. “This is because systematic rules make policy more predictable and therefore helps the public and markets make better decisions. Moreover, if policymakers choose to deviate from the guidelines, they are forced to explain why and how they anticipate returning to normal operating practices. Systematic policy also reduces the temptation to engage in discretionary policies.”
But, Plosser said he believes the FOMC “is still some way from agreeing on one systematic policy rule or reaction function. Such choices will involve elaborate discussions and agreement on the appropriate class of models and an agreed-upon loss function. One way to move toward more systematic policy would be to describe the variables that are important for our response function.”
He added, “If we choose a consistent set of variables and systematically use them to describe our policy choices, the public will have a greater ability to form judgments about the likely course of policy. This would reduce uncertainty about policy and promote stability.”
Finally, Plosser reiterated his concern about the central bank’s independence. “Pressure can manifest itself in calls for higher inflation or for central banks to act as lenders of last resort for failing governments. Yet central banks have also contributed to the breakdown of the boundaries by engaging in credit allocations to particular sectors, such as housing, and bailouts to particular firms, such as Bear Sterns,” Plosser said. “Thus, the fiscal authorities and supposedly independent central banks have acted in ways that undermine central bank independence. I believe this is a dangerous path and one that needs to be changed. We need to restore the boundaries.”