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Before the The National Economists Club, Washington, D.C.
September 9, 1999

Transparency and Responsibility in Monetary Policy
It is a pleasure to address the National Economists Club. I understand that the Club is an
educational organization with the goal of encouraging and sponsoring the public discussion
of significant economic issues. This is a worthy goal, and I am pleased to support it.
Today I would like to spend a few minutes discussing the issue of transparency and
responsibility in monetary policy. I am sure you will all agree with me that the first task of
the monetary authority is to get the right policy setting to achieve national economic
objectives. However, that task is complemented by and intertwined with another -- telling
the public, both the general public and active market participants -- what the central bank is
trying to accomplish, what forces it sees impinging on meeting its goals, and how it might
cope with those forces.
The latter job of communication has received increasing attention in recent years as central
banks worldwide have moved toward greater "transparency" in their operations, objectives,
and economic assessments. In my view, this trend is healthy and should be extended when it
would be useful. But we must be mindful that this new openness can have an impact on how
effectively central banks pursue their primary mission -- making the best possible monetary
policy. I want to take a few minutes to review the actions taken at home and abroad toward
greater transparency, and assess some of the issues that arise as central banks contemplate
further steps in this regard.
Of course, the views expressed here are my own and should not be interpreted as the
position of the FOMC or the Board of Governors.
The Recent Trend Towards Openness and Transparency
Let me start this discussion by focusing on the United States. The Federal Open Market
Committee in recent years has increased in several ways the transparency with which policy
decisions are made and implemented. In 1994, the FOMC began formally announcing,
immediately after any meeting in which a policy action had taken place, the change in the
targeted federal funds rate and a brief rationale for the decision. Until that time, changes
were "signaled" through open market operations. It sometimes took several days before
market participants and the broader public were certain that a new policy setting was in
effect. In that earlier regime, the public rarely received a prompt explanation for the change.
This year, the FOMC went a step further and began a policy of communicating major shifts
in its views about future policy even when the current policy setting has not changed. The
idea is that providing more information about the Committee's views of the economic
outlook may allow financial market prices to reflect more accurately the likely future stance

of monetary policy. The Committee made its first such announcement after the May
meeting. Both the markets and the Committee are learning to live with the new disclosure
policy, and our experience will help to guide any subsequent modification of these practices.
As technology continues to reduce the costs of disseminating information, and as Americans
participate in financial markets in greater numbers, the Federal Reserve has endeavored
more broadly to improve communication with the public about its views and actions. A
major component of that effort is our website. The texts of policy announcements,
testimony, speeches, and minutes of meetings are available through this medium
simultaneously with their initial release or presentation. As a consequence, the public and
market participants can form their own views on the implications of these texts, and do not
rely solely on press reports for interpretation.
These changes have been part of a broader trend among central banks in the industrialized
world. For example, in 1997 the Bank of England took a number of steps to increase the
openness and transparency of its policy making. It now announces monetary policy changes
immediately after meetings, provides press releases or conferences at pre-announced times
following monetary policy meetings, and has shortened considerably the lag time in releasing
its meeting minutes. The press conference announcing its quarterly inflation report is also
now televised.
Others have become more transparent as well. In 1998, the Bank of Japan's governing law
was revised. The Bank now announces policy changes immediately after meetings, publishes
minutes of the meetings, and produces two formal reports each year on monetary policy,
which it explains to the Diet.
The new European Central Bank incorporates a number of these aspects of openness. It too
announces policy changes immediately after meetings, along with a detailed rationale in a
press release or conference. Furthermore, it intends to sometimes provide occasional
post-meeting announcements that give a sense of the direction of future policy when the
current policy setting has been left unchanged. The ECB also publishes a Monthly Bulletin,
which provides an assessment of monetary, financial, and economic developments, and
explains monetary policy decisions of the Bank.
Openness and the Effectiveness of Policy
I believe that there are two main forces driving this move towards greater openness and
accountability. The first is that openness may improve the effectiveness of monetary policy.
The Federal Reserve controls a very short-term interest rate -- the federal funds rate -- but it
is the longer-term interest rates at which businesses and households borrow to finance
spending on capital goods, homes, and durable goods which matter most for the economy.
Those longer-term rates reflect expectations of future short-term rates, as well as a premium
for uncertainty. If the monetary authority can be clearer about what it is doing now and
plans to do -- not in the sense of setting future moves in stone, but rather in terms of
explaining risks that might influence future policy -- then market participants can improve
their expectations of future short rates, and possibly reduce the premium for uncertainty.
Both of these changes ought to bring the rates that matter most for the macroeconomy into
closer alignment with the intentions of monetary policymakers.
Openness on the part of the central bank does not guarantee that markets will accurately
forecast interest rates, however. Markets can err because the economy changes or because,
despite greater openness, they don't fully understand the central bank's intentions. One

aspect of this seems to be a tendency to extrapolate the recent trend of rates into the future.
For example, after a series of tightenings in 1994, the federal funds rate topped out at 6
percent, and short-term Treasuries remained below that level for virtually the entire
subsequent five-year period. During this period of tightening five-year Treasury yields
soared to nearly 8 percent, a rate never fully justified by the extent of firming in short-term
rates, suggesting that greater openness by policymakers does not preclude the natural
uncertainty involved in interest rate forecasting.
I might note that the decline in the usefulness of the monetary aggregates may have
contributed to the type of openness and transparency in use today. The regime targeting
money growth was, in a sense, a transparent one -- the targets were contained in the
biannual Humphrey Hawkins report and widely known, and money numbers were published
weekly. As the monetary aggregates became less reliable and consequently receded in
importance, maintaining openness called for increased communication about the rationales
for discretionary interest rate policy.
I do not wish to leave the impression that market participants accurately anticipating policy
actions is sufficient for central bankers to play their assigned role. While a tighter link
between monetary policy and long-term interest rates may lessen the need for the central
bank to move its policy instrument as much or as quickly, it should be clear that markets are
not a substitute for monetary policy action. Market movements in response to anticipated
central bank actions must be validated when they are, in the view of the policymakers,
correct, in order for the market to continue to reflect the intentions of policymakers.
Openness, Independence, and Democracy
A second force behind the trend towards openness and transparency is the increased
importance attached to, and increased prevalence of, independent central banks. The notion
that central banks need to be insulated from political pressures, especially regarding the
financing of national budgets, has been embraced and implemented throughout much of the
developed world. And, in many cases, openness and transparency on the part of the central
bank have been something of a quid-pro-quo for that independence. Here I am referring to
independence of instrument rather than independence of goal. It is appropriate that in a
democracy voters' representatives should decide the central bank's ultimate goals, as they
have in the U.S., for example, by providing the Federal Reserve with a mandate to pursue
stable prices, maximum employment, and moderate long-term interest rates.
The main reason that central banks need to be free of political pressure in using their
instruments is that effective monetary policy requires a distant time horizon. Because
changes in monetary policy generally affect output well before inflation, policymakers with
nearer time horizons could be tempted to favor output in excess of capacity, at the expense
of higher inflation in the future, and the well-known and inevitable disruptions that
accompany it.
Most countries have come to believe that the solution to this problem lies in providing the
central bank with independence in choosing settings for its policy instruments, and with an
institutional structure protective of that independence as well. For example, Federal Reserve
governors' terms are long and staggered, the Federal Reserve's budgets are not subject to the
congressional appropriations process, and it has no obligation to purchase or support the
prices of Treasury debt.
Along with their independence, central banks are required to account for their decisions in

various ways. This too is appropriate in a democracy: the public has a right to know what an
unelected body as important as the central bank is doing, and why. To some extent,
accountability is fostered by openness and transparency because letting people know what
you are doing gives them the tools to hold you accountable. The Federal Reserve's
accountability is collective, and it is often centered in the office of the Chairman. For
example, while the minutes of FOMC meetings generally refer to views of "members of the
Committee," the Chairman represents the Committee in testimony and answers questions
about the semi-annual Monetary Policy Report to Congress under the Humphrey-Hawkins
law. When a committee makes policy, a process involving consensus building and
compromise, collective rather than individual accountability seems preferable because
policies are not simply weighted averages of members' wishes.
Having outlined some of the advantages of transparency and accountability in central
banking, let me note that there are limits to how open central banks can practically be. The
Federal Reserve, like many but not all central banks, releases minutes after its next regularly
scheduled meeting. The ECB, representing a potentially more diverse set of national
constituencies, has decided neither to release minutes nor to publish the voting behavior of
its individual members. In this way, it hopes to avoid pressures to act in what may be
perceived to be a national interest rather than in the interest of the euro area as a whole.
Similarly, most central banks omit committee members' names in the discussion portion of
the meeting minutes, for fear that attributing remarks during the discussion would undermine
the free ranging nature of meetings and encourage members to arrive with prepared
positions. In fact, many members of the FOMC now do rely on prepared remarks for certain
segments of the meetings, in part due to the greater transparency that they face, given that in
the mid-1990s transcripts of meetings started to be released after five years. To the degree
that policy decisions benefit from the give and take of opinions and evidence at meetings,
something less than full openness to public scrutiny is required to assure the quality of
monetary policymaking.
Price Stability, Inflation Targeting, and Credibility
While central banks' mandated goals often include many things, price stability has emerged
as the preeminent one, either formally -- as in inflation targeting countries or the Maastrict
Treaty establishing the European Central Bank -- or informally, through a greater
understanding of how economies work. That is, policies that foster low inflation are more
likely to deliver high employment and maximum sustainable output growth as a by-product,
while policies which aim directly to keep employment and output high are more likely to
result in poor inflation performance. To paraphrase Chairman Greenspan, the economy
works best when inflation is so low that businesses and households do not have to take it
into account when making everyday decisions. In the short run, however, difficult choices
may be required about the timing and magnitude of policy actions consistent with achieving
price stability.
One approach to such difficult choices, as I have mentioned, is to mandate a quantitative
inflation target for the central bank, or to have the central bank select an inflation target that
it must endeavor to achieve. A number of other countries, like Britain, have adopted
inflation targeting monetary policy regimes. In many cases, that shift has been part of a
move toward greater independence of central banks. Such regimes might lend themselves to
both openness and accountability. A single quantitative goal might focus explanation of
policy actions and provide a simple yardstick for assessing performance. However, this
approach faces at least two sets of important issues.

The first is what to do about supply shocks, like large increases in oil prices, which tend to
increase both inflation and unemployment. Many of the countries that have adopted
inflation targeting avoid having to respond to the first-round effects of these disturbances by
targeting a "core" price index that excludes goods like food and energy that are often subject
to shocks. However, increases in raw materials prices will still tend to pass through to higher
prices for other goods, and thus raise core inflation, perhaps above the target rate or range.
In such cases, bringing inflation back down rapidly may entail high costs in terms of
unusually elevated output gaps and unemployment rates.
A related issue is which other price changes, beyond those induced by supply shocks, the
central bank should ignore in inflation targeting. Some central banks use indexes that
exclude certain prices, such as mortgage rates, in order to avoid the perversity of tightening
policy feeding into higher measured inflation for the targeted index. Occasionally, central
banks effectively make special adjustments for other price changes, such as excise tax hikes,
that clearly have an impact on "core" price indexes but do not signal an imbalance between
demand and potential supply that might give rise to broader inflationary impulses.
Inflation-targeting regimes may allow some consideration of real-side costs either by
specifying relatively long adjustment periods, to allow a high probability that the central
bank can bring inflation down to the target within the allotted time, or by including "escape
clauses" that grant temporary exemptions for large supply shocks. The question then
becomes whether the use of either of these elements of flexibility maintains the credibility of
the central bank better than a system of multiple objectives, like that of the Federal Reserve.
The longer the policy timeframe, the less content there is to an inflation-targeting regime,
and presumably the lower is its credibility. Similarly, the more often a central bank has to
declare emergencies, use escape clauses, or otherwise allow price increases to go
unchecked, particularly when the rationale for such decisions is difficult to communicate to
the public, the less credibility it will have.
Why is credibility so important? There is a large theoretical literature on credibility in central
banking, arguing for the most part that central banks need independence to be credible
inflation fighters, to be able to disinflate at a lower short-run output, and social, cost.
However, the evidence does not support a particular empirical relationship between
credibility and costs of disinflation, nor one between independence and costs of disinflation.
In the real world, there are two reasons why central bankers still prize credibility, even if it
cannot be shown to reduce the costs of disinflation. First, central banks need the latitude to
change operating policies when circumstances warrant -- such as de-emphasizing growth
rates of monetary aggregates when their velocities become unstable -- without the markets
fearing that a central bank's commitment to the goal of price stability has been compromised.
Second, credibility is an asset during a financial crisis, when the central bank may need
temporarily to take extraordinary measures. For example, it was helpful in the fall of 1998
for the markets to understand that the FOMC's policy easings represented a response to a
financial crisis, rather than a reduced concern about inflation.
The second issue with inflation targeting is what rate or range of inflation to choose. A rate
above zero (in terms of published inflation indexes) may be appropriate, for a couple of
reasons. One is that it may be difficult to conduct monetary policy at levels of inflation near
zero because nominal interest rates -- including the central bank's policy rate -- cannot be
below zero. Many observers believe that monetary policy in Japan is constrained in this way,
with its current policy setting an essentially zero short-term interest rate. A second reason is

the statistical biases in inflation indexes, resulting from slow inclusion of new goods,
improvements in quality, substitution from more expensive to cheaper goods, and other
factors. In the United States, the 1996 Boskin Commission report, estimated that these biases
may have overstated true inflation in the consumer price index at that time by three-quarters
to one-and-one-half percentage points per year. In such an environment, a central bank
mandated to pursue price stability can be flexible according to the circumstances, while one
with a numerical target may need to obtain formal modification of its objectives.
The movement towards more central bank transparency, independence, and accountability
that has taken place over recent years constitutes an exciting and welcome development. In
striking the appropriate balance going forward, the advantages of further steps must be
carefully weighed against the risks of impairing the deliberative process or indeed
destabilizing financial markets. By proceeding cautiously, but keeping the goal of optimal
transparency and accountability in mind, I am confident that central banks will continue to
contribute to the national welfare in their respective countries.

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