NEW YORK – Although it would not end difficult policy choices, an explicit monetary policy framework would improve monetary policy’s effectiveness, Federal Reserve Bank of Philadelphia President and Chief Executive Officer Charles I. Plosser said Tuesday, noting that he would take even more steps than just flexible inflation targeting.
While the U.S. has historically used discretion rather than a framework to ser monetary policy, steps have been taken “toward the more mainstream approach of flexible inflation targeting,” Plosser told the Union League Club, according to prepared text of his remarks, released by the Fed. “In particular, the Fed, especially under Chairman Bernanke, has become increasingly transparent and has worked to improve its communications with the public and the markets. It has recognized and stressed the importance of keeping inflation expectations well anchored. It has become more transparent regarding the Committee’s economic outlook over both the short and the intermediate term through the publication of its Summary of Economic Projections.”
Even with an explicit monetary policy framework “a good deal of judgment needs to be used in setting appropriate monetary policy,” he said. He said a framework “would improve monetary policy’s effectiveness in meeting our mandated objectives while increasing transparency and accountability.”
But the Fed could “further improve and strengthen its approach to policymaking” with several steps: clarifying and setting an explicit inflation objective; providing more information about the expected path of policy; and being more explicit about the Committee’s reaction function.
Generally, the belief is the Fed’s job is keeping inflation at 2% or less. “So I see no reason for the FOMC not to simply make explicit that its longer-term inflation objective is 2%,” Plosser said. “Making such a clear and explicit statement should give the public confidence that the Fed’s commitment to its price stability mandate is a credible one. Being explicit about our inflation objective is fully consistent with the Fed’s statutory dual mandate. Given that dual mandate, the structure of the economy, and the magnitude and frequency of typical economic disturbances, I would anticipate that when inflation deviates from the objective in the short term, it could be brought back to 2% within two to three years or less. But the timing would depend on the size and nature of the shocks to the economy. In deciding how quickly to move toward the inflation objective, the FOMC would always take into account the implications for near-term economic and financial stability and would continue to appropriately use its judgment in setting policy to promote fulfillment of the dual mandate.”
While the Fed has, at times, given expectations about the path of policy, using phrases like “extended period,” or, even saying that rates were likely to be kept low until “mid-2013,” they tend to be vague, or suggest that monetary policy would not be “contingent on how the economy evolved.” Plosser said, “I believe policy should always be a function of the state of the economy.”
He suggested offering Committee members’ underlying view of “appropriate policy.”
“This additional information would provide a useful picture of the range of views of future policy as envisioned by the policymakers,” he said. “These views would not constitute a commitment to follow a particular path but would evolve as economic conditions changed. This information would add a useful signal to the markets as to the thinking of the Committee on an ongoing basis.”
The third suggestion calls for policymakers to detail the factors that will influence their policy decisions. “I have long argued for more rule-like or systematic policymaking. This means making policy decisions using available economic information in a consistent and predictable manner. We don’t know what the future holds, but we can be more systematic about how we use economic data in formulating our policy.”
Plosser stressed that the fed should not aim for inflation higher than 2%. “By increasing inflation, some argue that we could lower the real rate of interest and increase monetary accommodation for as long as it takes to bring the unemployment rate down by a substantial amount. At that point, the goal would be to return inflation to a lower, more stable level,” he said. “But for this strategy to work, the public must have complete confidence that the Fed will be able and willing to bring down inflation in the future. If that confidence wanes and inflation expectations begin to drift up, this strategy will fail.”
