Transparency in the Practice of Monetary Policy

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This has been a very useful conference in my view, and I am honored by this opportunity to be a part of it. As some of you may know, I was the second choice for this slot, but that doesn't bother me at all because the first choice was Don Brash, the Governor of the Reserve Bank of New Zealand and a pathbreaker in bringing both transparency and accountability to central banking in practice. I won't be able to fill Don's shoes completely, but I have a strong interest in this topic, and I am very happy that Bill and Dan saw fit to give me the opportunity to share some thoughts with this distinguished group.

Actually, it is hard to imagine that anyone interested in improving the conduct of monetary policy would not be interested in this topic. There is a growing consensus among monetary economists at this point that the impact of monetary policy on expenditure is transmitted primarily through the effects of policy actions on expectations regarding the future path of short-term interest rates rather than the current level of the overnight rate.' Further, the more financial markets know about the reasons for a central bank's current policy actions and its longer-run policy intentions, the more likely it is that market reactions to policy actions will reinforce these actions and increase the effectiveness of stabilization policy. It follows that central banks should be highly transparent regarding both their long-term policy objectives and the shorter-term tactical actions they take with policy instruments.

Against this background, it seems to me that the Fed, along with other central banks, has made considerable progress in increasing transparency in recent years. When I first joined the Fed back in 1970, to the extent that anyone thought explicitly about transparency issues at all, the idea seemed to be that limited transparency-or even no transparency-was best. Central banks in industrial democracies were thought to work most effectively behind the scenes, away from the glare of public scrutiny, at least in part because they could then quietly take appropriate actions that might be politically unpopular, or, more broadly, difficult to explain to a public not well versed in the intricacies of finance? There was also a belief in some quarters that central banks could enhance the effects of certain policy actions-most notably foreign exchange market intervention operations-if they kept market participants uncertain about their intentions.

Attitudes toward transparency appeared to change in the 1980s, partly reflecting progress made by economists in understanding the monetary policy transmission mechanism, and probably partly because of public demand, particularly in the United States, for greater openness in government and public policy generally. (As you may recall, the most widely read popular book about the Fed and Fed policy in the 1980s was somewhat derisively titled Secrets of the Temple.) Further, in the early 1980s, Chairman Volcker publicly took responsibility for reducing inflation from its then high level, and subsequently took strong and temporarily painful actions to accomplish the reduction. Some public explanation of the need for these steps was required, and this need probably facilitated the transition to viewing transparency more favorably. In any case, given the normal resistance to change in bureaucratic organizations, I believe the Fed has made remarkable progress over the last decade or so in opening up its conduct of monetary policy to market and public scrutiny.

Since the Fed is now quite open regarding many important aspects of its policy strategy and operations, and in view of the strong performance of the U.S. economy in recent years, at least up until the last several quarters, one might reasonably ask whether still greater transparency is necessary or even desirable in U.S. monetary policy. I think it is, and I will try to make this case in the next few minutes. Let me comment briefly on four points: (1) the transparency of our long-term inflation objective, (2) what I'm going to refer to as the "intermediate-term transparency problem," (3) the transparency of our policy directive, including its "tilt," and (4) the role of testimony, speeches, and other public statements by Fed officials in providing transparency. …