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CLEVELAND. ADDRESSES .
HOSKINS . II9.
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l:00 p.m., E.S.I.
January 19, l9g9
Monetary Pol i cy, Information and Pri ce Stabi l i ty
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"á$s"
l,l. Lee Hoski ns , pres i dent
The Fedeial Reserve Bank of Cleveland
The Akron Roundtable
Akron,.l9,
Ohio
January
'1989
Monetary Pol i cy, Information and pri ce Stabi I i ty
Introduction
time in which we live has often been described as the Information
The
Age. Countless books,
have been devoted
implications.
of
thought
newspaper and magazine
articles,
and broadcast hours
to the information expìosion and have explored its
Economists recognized
early on that information could
be
as a service whose supply, demand, and price could be analyzed ìike
any other commodity. For a
variety of reasons, however, economists were slow
to incorporate features of information markets into their analysis of other
kinds of economic activity. Th'is unfortunate situation has been changing very
rapidly during the past decade and the economic aspects of information are now
regarded as absoluteìy central to the understanding of almost all market
phenomena.
Economic research on what peopìe know, how
react has also caused a revolution in
pol i ci es
.
Economi
sts
now recogni ze
they learn
it,
and how they
how economists analyze macroeconomic
that
peopl
e i nvest
cons i derabl
e amounts of
time and other resources monitorjng economic poìicy and that they base private
decisions on what they expect to happen. Then they formulate plans that are
to make themselves as well-off as possible if their expectations
realized. For example, ìf peopìe expect their tax liabilities to rlse in
designed
future
because
of
are
the
large budget deficits today, they have an incentive to
shelter their future
income from taxes by
aìtering their pattern of
spending
-2and investment. Consequentìy,
tax
revenues may be even lower
in the future
than the government expected.
Contemporary
thlnking about market expectations recognizes that
markets
often make mistakes about what policies the government wi'll pursue.
people work hard
to form correct
and unbiased opinions about
But
future events,
including government policies, in an effort to be correct on average.
people are correct on average about future
If
policies, then government
policymakers should not count on being able
or influence the
public for long periods of time. For example, if federal deficits rise every
year despite announced plans to reduce them, future announcements wlll be
di scounted and eventual ly be i gnor:ed. Pol i cymakers need to reconsi der thei r
own
pursuade
roles in our economic system in light of these views about information.
Our socìety has established many goals
low rates
posi
to
of
tions,
unemployment and
for
economic performance, includìng
poverty, more balanced federal budget and trade
and pri ce stabi I i ty. Responsi bi I i ties
for
accompì i shi ng these
goals are assigned to various governmental agencies, and the actions
policymakers can
clearly affect the operating
The Federal Reserve System seeks
employment by maintaining
to
maximize
of
some
environment faced by others.
our nation's production
and
price stability over time. Over short intervaìs of
time the Federal Reserve can strongìy influence production and empìoyment, but
its
ìong-term influence
is
weak
or non-existent. 0ver ìonger time periods,
of output, employment, and wealth surely depend on a nation's
resourcefulness in utÍìizing land, labor, and capital. Monetary policy
growth
can
best promote an efficient economic system by establishing a stable prìce level
environment. This environment encourages decision makers--private
and
-3public--to
make long-term plans and contracts
without concern that future
inflation will ìater penalize them. The Federal
that can control the U.S. price level over time.
I
am
especiaììy interested in
how
Reserve
is the only agency
the Federal Reserve could enhance our
nation's economic efficiency by providing and disseminating monetary po]icy
information differently than we do at present. Our infìation rate has hovered
rate for about half a dozen years. Last year the rate
rose and this year the rate could easily exceed 5 percent. Some people recall
around the 4 percent
that infìation rates
were about twice
that
amount
regard 4 to 5 percent as an acceptable standard
only eight years ago,
for
and
success. But a 4 to
5
percent inflation rate meant that the overall price level increased by 30
percent during the last six years and the purchasing power of the dollar
decìined by 20 to 25 percent.
I
am deeply
disappointed by this kind of
inflation performance. Continuing inflation rates of this magnitude do not
seem today to be regarded as a pressing economic probìem, yet cumulatively
they have eroded the value of our dollars and impaired our economic efficìency.
I'd like to suggest that we as a nation embrace the goal of price leveì
stability
and begin immediately
to attain zero inflation in a few years.
Federal Reserve couìd make such a program more credible and effective
clearly
periodi
announcing such a goal and a timetable
c statements, the Federal
for
achieving
it.
Reserve could comment specifi cal
The
by
Through
ly on how
current economic developments are ìikely to affect the inflation rate over
time, and how the Federal Reserve plans to react. In other words, the Federal
initiate an 'information program designed to enhance the
of this goal. I recommend this process because I think ft will
Reserve could
attainment
maximize our
nation's
economic performance over
times the Federal Reserve
the long run, mindful that at
will make some mistakes.
-4t{hen
I
speak
or write about price stability
I
mean
zero
infìation.
I
think a strong case can be made for having the paramount goaì of monetary
policy be to eliminate inflation compìetely. Inflation obscures the
information otherwise generated by markets. Inflation adds "noise" to
the prìces we see and hampers our
relative prlces
and changes
of
between changes in
in the overall price level. Infìation leads to
socially inefficient resource
the consequences
abiìity to discriminate
all
depìoyment because peopìe demand
of inflation.
Peop'le
instruments that would be unprofitable
protection from
create financial institutions
and
in the absence of Ínflation. Inflation
interacts with our tax system in costly ways, leading to less total
investment. The tax system can influence the allocation of resources across
sectors
of the economy, the timing of
structures. Inflation
investment, and corporate financial
can magnify these influences leading
to
undesirable
consequences. Inflat'ion can be regarded as an information impurity that
reduces economic
growth. Any nation could Ímprove the welfare of
its
citizens
by el iminating infIation.
all
of inflation is
rather arbitrary and would likely be viewed as such by the public. For
exampìe, if the Federal Reserve announced a goal of 5 percent inflation, the
l'lhy push
public should
some
the way to zero inflat'ion? Any positive rate
assume
that 5 percent inflation ìs being taken as a tradeoff for
other economic objectives (otherwise why not a goal of zero inflation?).
But next year the Federal Reserve might accept some different inflation rate
of changing economic or pol itical circumstances. Consequently, if
Ínflation is greater than zero, it seems to me that people have lÍttle reason
because
to expect inflation to be stable over tìme. Zero inflation is a qualitatively
different economic env'ironment, and a monetary pol icy designed to el iminate
ìnflation would be a qualitatively different po'licy.
Peop'le wouìd recognize
-5it
as a declaration
by the
Federal Reserve
tradeoff any inflation for other
economÍ
c
that i t
wì I
obj ecti ves
I
not attempt to
.
Monetarv Pol i cv and Central Bank Credi bi I i tv
Hhy
is it
important that monetary poìicy be credible and what are the
of a credible monetary poìicy likely to be? A credible monetary
poìicy is one that an informed public believes will be successful at attaining
elements
the goal set by policymakers. The goal needs to be feasible, cìear'ry
understood, and publicly supported.
If
the goaì
is not feasible
and does not
it will ultimately not
be cr:edible. The policy designed to attain the goaì will be more effective
'the more clearly it is understood. If the poìicy is not effective, ìt wilì
command
public support, any poìlcy designed to attain
eventually be abandoned and replaced with another poìicy designed to attain
the
goa
l.
in the United States
Market participants
that only the Federal
through the quantlty
to create.
Reserve can
of
and around the world recognize
control the U.S. price level over time
dollar-denominated money
People who trade
it
allows the banking
system
in foreign or domestic markets with U.S. dollars
do so with expectations about the future purchasing power
If
dollar-users think that their
dol
lars to offset
of
those dollars.
over real resources Ís
likely to
erode through inflation, they wiìl require an interest rate premium to hold
expected purchasing-power
certainìy cause the U.S.
had more fai
command
economy
th i n pri ce I evel
Such expectations wi ì l
to operate less efficÍently than if
stabi ì i ty over ti
If the social benefits of zero inflation
I
erosion.
peopìe
me.
are as significant and obvious as
cìaim they are, then why has the United States not already enthusiastically
supported
that goa'l and moved closer toward attaining
lt?
The
simplest, and I
-6believe most compeìling, answer is that historically the process
i
nflation has been associ ated
wi
th economi c recessions.
Few
of
reducing
observers
woul d
that there could be a short-run cost to achieving price level stability,
but there are ways to minimize these costs and I think the investment payback
deny
period would be rather
short. I
come
to this conclusion after considering
how
the Federal Reserve couìd more credibly provide information to the pubìic.
I like to think that the Federal Reserve, because of its institutìonal
structure and reputation
for integrity,
could more consisten¡y conduct
policy with a higher degree of credibility. The Federal Reserve has
the authority to set a specific numeric goaì for the inflation rate over time,
to announce that goal to the public, and to implement policies designed to
monetary
accomplish the
goal.
exactly this lvay.
The Federal Reserve does
l4e have
several goaìs.
not presentìy operate in
Among
them
is price stabiìity
over
time, but we have not provided a timetabìe for achieving thÍs goaì.
Essentially, we ask the pubìjc to trust us to do the right thing: to alìow
the price level to move over time in a tl,ay that we think the public will find
acceptabì e.
Peopl
e attempt to di sti ngui sh between credi
bl
e i nformation and rhetori
c.
In the final analysis, credibiìÍty accrues to those who visibìy make choices
in support of their announced goa'ls. The Federal Reserve lost some
credibìlity durfng the 1970s by not acting forcefulìy enough to arrest
inflation.
The Federaì Reserve restored some
credibility in the ì9g0s by
reducing inflation substantially and, beyond this, through an occasional
wi I I i ngness to err on the si de of monetary ti ghtness.
Market parti ci pants
wouìd probably say
goal
that Federal
Reserve
policies today are credlble
if
our
is to keep inflation in the 4 to 5 percent range. Based on our current
actions, however, attaining zero inflation in the next few years probably
has
-7
very
little
public
about future
credibility.
inflation affects
-
And, I hasten
economic
to add, the public's
activity in
judgement
Ímportant ways today.
Information and Credible Monetarv policv
In theory, a nation's
information to maintain
monetary authority need not provÍde much public
its
own
credibiìity.
A central bank could select
a
goal and impìement policies that actuaììy attain this goal regularly, over
'long period
of time. As long as the monetary authority achieves the goal,
will
a
little time or effort in monitoring central bank policies
and actions. Peopìe will consistenily get the results they expect.
In practice, central banks will not always find it easy to achieve their
goal. unforeseeable events could pose problems: oil price surges and
people
spend
coìlapses, droughts, dramatic exchange rate fluctuations, changes in the
of
money, and ìarge
did not
abandon
attain it.
If
public deficìts to
its goal, it
may
name
a
few.
Even
if
the central
occasionally or even periodìcally
fail
use
bank
to
those periods become frequent enough, peopìe may reasonably
question whether the central bank has changed i ts goal
.
its credibiìity by telling the publìc that it
has not changed the goa1. Furthermore, it can expìain why its policies are
not efficacious. It can adopt and announce new policies des'igned to achieve
the goaì. If the central bank does not provide the public with enough
information about its activities, the public may thÍnk that the goaì it had
supported was replaced with some other goaì--one that it may or may not
support. 0r the public may think that the central bank's new polìcÍes will be
i neffectual . l4hatever the i nformation shortcoml ng, economi c i neffi ci ency i
s
A central bank can assist
likely to result.
-8Conducti ng monetary poì i cy i n the Uni
ted States
became unusual ì y di
ffi cul t
in the 1970s. Inflation rates became larger and more highìy variable than had
been the case for several previous decades. Frustratìons mounted over
'inflation's intractabi I ity.
it
The Federal Reserve repeatedly took actions that
inflation, but the public had come to expect that
would accelerate. As confidence in the Federal Reserve
thought would reduce
inflation nevertheless
slipped, the pubìic concluded that the Federaì Reserve should provide
information about
its
goals and operating procedures.
l'lith the enactment of the
Growth Act
more
Full
(Humphrey-Hawkins)
Employment and Balanced
of'1978, Congress and the Administration essentially agreed that
the Federal Reserve should regularly and publicìy discuss
economic conditions and
its
view
of
current
its projections for economic Arowth, inflation
unemployment. Moreover, the Federal Reserve was required
and
to report its
for various monetary aggregates, po1icy variables over which it
indirect control. The bas'ic premise was that the Federal Reserve should
object'ives
has
pubìicly to achieving certain obJectives for monetary aggregates, which
Ín turn, were loosely associated with more meaningful economic goals. The
commit
required semi-annual testimonies to Congress have
become prominent sources
of
publìc information about monetary policy, partly because of the information
provided and partly because there are so few additional sources
i
of
public
nformation about the Federal Reserve,s i ntentions.
The law does not require the Federal Reserve
monetary growth
rate targets unti I
money groh,s
3 percent, thought to be consistent with zero
to set successively
at
some predetermi ned
inflation.
targets whenever
it
rate,
The requÍred
reporting format is flexible enough to permit the Federal Reserve to
its monetary aggregates
lower
beìieves changes are
change
say
9warranted.
The framework
is attractive and sensible
because
it
does not
presume
a constant relationship between economic events most direct'ly
controlled by the Federal Reserve and economic results most desired by the
public. During the past ì0 years, as the customary relationships between
money and economic
activity
"broke-down," the Federal Reserve has varied
emphasis among the aggregates, moved
even added and removed
target ranges around considerably, and
particular monetary aggregates from the
list of those
targeted.
Aside from Humphrey-Hawki ns testimonies, the Federal Reserve regularly
reìeases some information (Policy DÍrectives) about each
seven weeks
dÍscussion
meeting
six or
after the meeting. The Policy Directive contains a brief
of
whether the
FoMC
how
FOMC
the
FOMC
viewed economic conditions and
voted to change poìicy
in some way.
a statement
The votes
of
about
individual
committee members are provided.
time to time there are discussions about releasing the policy
Directive much sooner after an FOMC meeting. Those people seeking more
From
information (or more timely information) believe that individuals could
better decisions about their
make
affairs if they know more about the
Federal Reserve's goal s, objecti ves, vi elr of economi c condi tions and poì i cy
intentions. This is an argument for which I have much respect and sympathy.
economic
Although I personally have no quaìms about immediateìy releasing the
I
FOMC
fair amount of the Policy Directive debate
faìls wide of the mark. After all, the Policy Directive Ís already released,
although on a deìayed basis, to the pubìic. I am far more interested in
providing some informatìon that is not public at all--indeed, that does not
yet really exist. The Policy Dlrective may inform the public that the Federal
Poìicy Directlves,
do think a
_ t0
_
Reserve has chosen
much,
to tighten or loosen, but the public cannot teìl by how
for how long, or to what end.
Despite the very valuable public information provided by
the Federal
Reserve, I sense that something even more valuable is missing.
l.lhat is
missing from the pubìic domain is a cìear message about the Federaì
Reserve,s
inflation goaìs, stated in a way that the pubìic can actually use for its
decisions. The information would indicate how much inflation the Federaì
Reserve envisioned during the next few years and why
reasonabìe
is
goal.
The Federal Reserve could
most sensible, and how
policy'
it
amount constituted
also explain the policy
plans to exercise judgement as
The Federal Reserve could draw
and the methods
that
it
lt
Because
thinks
the Federal
its
goal
Reserve
has very broad
authority to decide on and implement the kind of monetary
poìicy it thinks is appropriate, I think the public will tend
to believe that
the Fed can effecti ve'ly accompr i sh what i t sets out to do.
Bevond Humphrev-Hawki ns
our
economy has an enormous
capacity to absorb and transm.it information.
In the afternath of the .l987 stock market crash,
Chairman Greenspan,s remarks
about proposed stock market reforms indicate substantial respect
ability of the non-financiaì
markets are reacting
economy
for
the
smoothly while financial
to surprise events. In a similar vein, I
that financial markets can absorb
use
to function
would argue
more information about monetary
it effectively, and that the entire economy will
a
executes this
a sharper distinction between
it'adopts to attain that goal.
own
poìicy,
can
ultÍmately benefìt.
Financial markets would be surprised less frequenily by the Federal
Reserve
they receive more information from it.
if
tì
The
public
spends ìarge sums monitoring and analyzlng the Federaì Reserve,
attempting to predict what
it will do.
People place bets everyday on future
inflation through their decisions to allocate resources across markets and
tìme' By being more explicit about what it is trying to accomplìsh--and what
it is not--the
Federal Reserve could make this process work
Federal Reserve Board,
better.
The
in its actÍons and statements regarding financÍal
market regulation, has been sensitive
to the costs that regulators can impose
on the public when resources are not free to flow to their most valuable
uses' Enhancing the available information about monetary poìicy should be
of confidence in the market process.
In the course of being more explicit about des'ired inflation,
regarded as a vote
and methods,
the Federal Reserve
timetables,
It may have to
work hard, from time to time, to command support for its goal.
It may
encounter an inflation path that differs from its multi-year projection. It
may find that its announced operating procedures
do not work as effectiveìy as
fi rst-thought, requi ri ng changes . In fai rness , however, I thi nk the Federal
Reserve
is already
may encounter some
problems.
subject to these pressures and has experienced each of
them
during the past decade.
Conclusion
For the past several years we have tolerated an infìation rate that eroded
the purchasing po¡rer of a dollar by 20 to 25 percent. Chances are that
inflation will accelerate further this year. The Federal Reserve has a stated
goal of achieving prìce stability over tÍme, where price stability
means zero
inflation, but has provided no timetabìe.
Each
year that inflation deviates.
substantialìy from zero, the Federaì Reserve could lose
some
credibiìity.
In
-12addition, as ìarger rates
of inflation
become embedded
in our economy
the
costs of eliminating that inflation escalate.
I think the public
acceptabìe solution
recognizes
to other
that inflation is neither costless nor an
economic
problems.
I
also think the
Federal
or eliminate the economic dislocations that sometimes
accompany its monetary policies by providÍng more information about its goals,
Reserve could reduce
methods, and timetables.
@FedFRASER