Academic journal article Economic Commentary (Cleveland)

A Perspective on Monetary Policy

Academic journal article Economic Commentary (Cleveland)

A Perspective on Monetary Policy

Article excerpt

This afternoon I will focus on two tenets that I believe should guide monetary policymaking. First, I am convinced that price stability enhances economic welfare by creating an environment in which people can make better decisions-decisions that are conducive to long-term economic growth and stability.

Second, I think that central banks can be more effective when they act systematically and transparently. In my remarks, I will talk about the behaviors that have made the FOMC successful in this regard.

Finally, I will conclude with a few remarks about the current state of the economy and monetary policy.

* Price Stability Enhances Economic Welfare

Let me start with my first tenet: price stability enhances economic welfare. Indeed, I regard maintaining price stability as essential for optimum performance of the overall economy. That is why price stability is a primary objective of monetary policy.

Under the leadership of my predecessors, the Federal Reserve Bank of Cleveland established a strong commitment to the primacy of price stability. These leaders saw the pursuit of price stability as the key to achieving the most favorable outcomes for sustainable economic growth.

Their position, that the FOMC should establish a policy of "zero inflation," or price stability as it became known, seems much more reasonable today. Back then, though, their perspective was viewed as radical. The conflict arose because some people thought that price stability and economic stabilization were not compatible goals.

Although price stability has been an explicit objective of monetary policy since the earliest Congressional mandate in 1946, the benefits of price stability were not widely appreciated until more recently. Today, monetary policymakers routinely talk about the positive benefits gained from achieving price stability.

Moreover, I believe that it is now widely recognized that sustained inflation-or deflation for that matter-is a monetary policy phenomenon. In other words, I think the Federal Reserve owns the sole responsibility for achieving and maintaining price stability in the United States.

* Acting Systematically and Transparently

Let me turn to my second tenet: central banks can be more effective when they act systematically and transparently. Only then will the public understand how to interpret individual policy actions.

I will elaborate on three behaviors that I believe have made the FOMC more systematic and transparent:

* Anchoring inflation expectations,

* Acting predictably, and

* Drawing on credibility to deal with unusual circumstances.

* Anchoring Inflation Expectations

First let me address the idea of anchoring inflation expectations. Economists and policymakers today agree that expectations play a key role in inflation dynamics. People who act on mistaken beliefs about future inflation make decisions that they may later come to regret. Because central banks control the trend rate of inflation over time, it seems natural for central banks to do everything they can to inform the public about the trend rate of inflation and to convince the public to regard the information as credible.

The FOMC did not have a formal, numerical inflation target as it set about to achieve price stability two decades ago, and it does not have such a target today. I think that the FOMC informally set an upper-limit guidepost for inflation after the turbulent 1970s, when inflation was very high and variable. The decade of the 1980s brought a definite improvement, with core inflation fluctuating in the neighborhood of 4 to 5 percent.

During the 1990s, the FOMC paid close attention to managing inflation expectations. Chairman Greenspan and other Committee members talked regularly about their commitment to achieving price stability. If you recall, some members spoke about "opportunistic disinflation," which was their way of saying that in the process of leaning against inflation, they were willing to take advantage of opportunities to lock in even lower rates of inflation when those situations presented themselves. …

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