Trends and the expectations for longer-term economic movements provide more insight than recent data when setting monetary policy, Federal Reserve Bank of Philadelphia President and Chief Executive Officer Charles I. Plosser said Wednesday.
"I believe it is a mistake for policymakers to focus too intently on the most recent numbers to justify a policy decision," Plosser said in remarks prepared for delivery to the Charlotte Economics Club. "Our data are always noisy and often subject to substantial revision, as we just witnessed with last week's GDP revisions and as we see regularly with the monthly employment report. Instead, we must focus our attention on the underlying trends and the likely path of the economy over the intermediate to longer-term horizon."
Additionally a long-term view is needed, Plosser said, because monetary policy actions work on a lag, so the effects "may not be felt for many quarters and maybe years in the future." So the economy in the short-term won't be "altered in any significant way" by current policy decisions. "We must look further ahead in assessing the appropriate stance of monetary policy."
Plosser noted the uncertainty about the future, which also "has implications for how we should approach policy."
Since the recovery started in mid-2009, the economy has made great strides, he said. "To me, that means we should no longer be conducting monetary policy as if we were still in the midst of a financial crisis or in the depths of a recession."
Economic progress "suggests monetary policy should begin to normalize. Keeping the funds rate target near zero when inflation is close to our goal and the economy is near full employment is both unprecedented and risky in my view," Plosser said. "Waiting too long to begin the process of raising the policy rate risks facing the possibility that the rate may have to increase rapidly when the time comes and that could prove unnecessarily disruptive. And waiting could also risk a more rapid pickup in inflation."
The lesson of the recovery, he said, "is how difficult it is for monetary policy to fine-tune real growth in the economy." Although the Federal open Market Committee took "aggressive actions" to speed the recovery, growth has been moderate. "Monetary policy has simply not proved to be the panacea that many had hoped. As I have argued on a number of occasions, I believe we have come to expect too much from monetary policy. We would be better served by greater humility and lowered expectations of the potential for monetary policy to manage real economic growth and employment."
Plosser, who will retire on March 1, also suggested a change in communication, saying the FOMC should describe a reaction function, the "key economic variables" that will impact policy and how policy will react to those variables. He criticized "date-based forward guidance," because without certainty about the future this forward guidance "cannot be very credible." But, he holds little hope that this change will occur.
