NEW YORK – While lauding the Federal Reserve’s continuing move toward transparency, Federal Reserve Bank of Philadelphia President and Chief Executive Officer Charles I. Plosser recommended the Federal Open Market Committee issue a “more comprehensive monetary policy report” regularly, even quarterly.
In an effort to further “improve communication and transparency,” Plosser made his proposal before the National Economists Club Thursday, according to prepared text of his remarks, released by the Fed.
“Currently, the Chairman testifies before Congress twice a year and submits an accompanying written report,” he noted. “In addition, the Chairman holds press briefings four times a year to summarize the SEP. I think there is an opportunity to combine these efforts into a more comprehensive report on monetary policy as many other countries do. The report would offer an opportunity to reinforce the underlying policy framework and how it relates to economic conditions in addition to summarizing the SEP.”
The Fed needs to raise “the public’s understanding of how policy will react systematically to changes in economic conditions,” he said, noting, “transparency is a journey, and not a destination.”
While some believe “monetary policy should remain a bit mysterious” and communicating “too much” may “backfire or result in confusion,” Plosser said these results likely result from communications that “lack clarity.”
“Others seem to equate clear communications with providing a degree of omniscience about the future – omniscience that, of course, doesn’t really exist,” he said..
Monetary policy has an impact on the “expected path of inflation. Uncertainty about this anticipated path can wreak havoc on financial plans and cause businesses and households to expend valuable resources to insulate their plans from unexpected and volatile movements in inflation,” Plosser said. “Thus, increased transparency about the central bank’s goals and objectives regarding inflation can improve economic efficiency and help anchor expectations of inflation.”
Policy also affects long-term interest rates by setting expectations for short-term rates. “Consequently, a better understanding of how policymakers will react to economic events over time can reduce uncertainty about the expected path of the short-term interest rate and so reduce the uncertainty and volatility of long-term rates,” he noted.
Lessening uncertainty about monetary policy may “help anchor expectations, improve the effectiveness of monetary policy, and reduce economic volatility,” according to Plosser. “It also improves economic efficiency by allowing households and businesses to make more informed decisions. Given these benefits, central banks have sought to improve transparency about the goals and objectives of monetary policy and how monetary decisions are made.”
Also, transparency augments the Fed’s accountability and independence and can increase its credibility, he said.
While hailing the January move by the Fed to set an explicit target for inflation and to offer “information on the policy path assumptions underlying the FOMC participants’ economic projections,” Plosser said, “more can and should be done.”
Plosser noted the “description of how policy will be conducted is not entirely clear,” and suggested that if monetary policy were more “systematic,” it would also be “more transparent and easier to communicate.”
Systematic, in Plosser’s definition, means policy would be made “in a rule-like way,” with “a systematic relationship between changes in economic conditions and the policy actions and choices made by the central bank.”
Since there can be no “certainty how economic conditions will evolve,” policymakers “cannot and should not say with any certainty what policy will be in the future,” Plosser argued. “But policymakers can provide information about the factors that will influence their policy decisions. Some call this a policy rule or reaction function.”
He continued, “I believe that the Fed should provide more information about its reaction function and communicate its policy choices in terms of that reaction function. It is not just about transparency. The practice of using systematic rules as guides to monetary policy imposes an important discipline on policymaking as well as improving communications and transparency.”
There would be situations when policymakers would need to “deviate” from the rules, he said, “but then they will be forced to explain why they deviated and when they anticipate returning to more normal operating practices. Requiring this type of transparency raises the bar that policymakers face to engage in discretionary policies in the first place.”
A consensus on such a policy imminently is unlikely, Plosser said, because FOMC participants “use different models and have different loss functions. However, there is reason to be optimistic since there is a growing literature on robust rules that work well in a range of models and reasonable loss functions.”
As a short-term alternative, Plosser suggested, “a set of economic variables to which monetary policy should react.”
The models on such rules indicates “respond aggressively” if inflation strays from the target, but calls for a less aggressive response “to deviations of output” from “potential output” or another measure of resource utilization.
There would be no need to “specify the precise mathematical rule,” just “key variables,” with policy decisions explained “in terms of changes in these key variables.”
Plosser said the FOMC would need to explain “how the variables in our response function changed” and resulted in a policy change. “If we choose a consistent set of variables and systematically use them to describe our policy choices, the public will form more accurate judgments about the likely course of policy – thereby reducing uncertainty and promoting stability.”
