Monetary Policy in the United States: A Brave New World?

By Williamson, Stephen D. | Review - Federal Reserve Bank of St. Louis, Second Quarter 2014 | Go to article overview

Monetary Policy in the United States: A Brave New World?


Williamson, Stephen D., Review - Federal Reserve Bank of St. Louis


Ben Bernanke chaired his last Federal Open Market Committee (FOMC) meeting in January 2014 and departed from the Board of Governors on February 3 after eight years as the head of the Federal Reserve System. So, the time is right to look back on the Bernanke era and ask how central banking has and has not changed since 2006.

There is plenty in the macroeconomic record from 2006 to 2014 to keep economists and policy analysts busy for many years, so in this short piece we can only scratch the surface of what is interesting about the Bernanke era. I will focus on three issues: (i) inflation targeting, (ii) Fed lending and other interventions during the financial crisis, and (iii) post-crisis Fed policy, in particular experiments with forward guidance and quantitative easing (QE).

INFLATION TARGETING

When Bernanke began his first term in 2006,1 think the big change people expected was an inflation-targeting regime for U.S. monetary policy, similar to what exists in New Zealand, Canada, and the United Kingdom, for example. While that may have been in the cards, by the time Bernanke had settled into the job, events had overtaken him and he clearly ended up with much more than he bargained for. In terms of how Fed officials think about their jobs and how the public thinks about the role of the central bank, the Feds objectives and its toolbox are far different from what existed, or was envisioned, in 2006.

Ben Bernanke was on record prior to his time as Fed Chair as a supporter of inflation targeting (see, for example Bernanke, 2004), which, as noted, had been adopted in other central banks, including those in New Zealand, Canada, and the United Kingdom. Bernanke (2004) argued that, in spite of the Feds successes in controlling inflation, beginning in the Volcker era, it would be an improvement if the Fed stated a specific target for the inflation rate.

While Fed communications during Bernankes term changed in ways that reflected more explicitly the dual mandate that comes from the U.S. Congress, the Fed ultimately stated explicitly that its target was a 2 percent per year increase in the raw personal consumption expenditures (PCE) deflator. In early 2012, a set of long-run goals for monetary policy were laid out by the Fed, which included this specific inflation target (see Board of Governors, 2012). This version of inflation targeting differs from that in some other countries (e.g., New Zealand or Canada) where there is an explicit agreement between the national government and the central bank that there will be an inflation target that is periodically renegotiated. In the United States, the central bank took it upon itself to come up with the inflation-targeting approach.

Figure 1 shows the path for the PCE deflator from January 1995 to February 2014, along with a 2 percent growth trend. This is quite remarkable, as inflation has actually not strayed far from the 2 percent trend path over this 19-year period. Thus, the Feds announced inflationtargeting approach was simply ratifying a policy that had implicitly been in place for a long time. Thus, while announcing the 2 percent inflation target may have been important in reinforcing the Feds commitment to low inflation, it appears that the Fed could have announced such a target in 1995 and that this would not have constrained its behavior. Perhaps surprisingly, once the Fed had announced the 2 percent inflation target, it began missing it on the low side, currently by about as much as at any time between January 1995 and the present.

THE FINANCIAL CRISIS: CENTRAL BANK LENDING, BAGEHOT'S RULE, AND MORAL HAZARD

It will take us many years to sort out what happened during the financial crisis and why. We do not even have all the facts yet, and I am sure there will be important revelations when the principals (hopefully including Bernanke) write about it. For starters, it is useful to read the transcript from a conference at the Brookings Institution in January 2014 (see Brookings Institution, 2014). …

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