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Communicating the Stance of Monetary Policy
University of Missouri–Columbia
Columbia, Missouri
November 4, 1999

I

have spent most of my professional life
studying monetary policy—trying to understand how policy actions affect the economy
and how policy might be improved. Those
were my concerns as an academic, and they
remain my concerns as a policymaker.
Since I arrived at the Fed, however, I have
come to appreciate another dimension of the
policy problem—how to communicate the stance
of policy to the markets and the general public.
As an academic—along with almost all other
academics, I believe—I took communication
issues for granted. It seemed to me that, if the
central bank pursued a well-formulated policy,
then that policy would be easily understood by
the markets.
The matter is not so simple. Try to explain to
someone how to ride a bicycle. Indeed, almost
anyone can learn to ride a bike by just doing it,
but almost no one can learn that by reading a book.
I won’t push the bicycle analogy further, because
I certainly don’t want to claim that monetary
policymakers shouldn’t read books! But actual
experience—just doing it, or watching up close
those who are—is very valuable as well. Deepening understanding of communication issues is
high on my agenda, but in this speech my aim is
to review the communication channels that are
important today. I’ll begin with a brief discussion
of why communication is so important for a successful monetary policy.
Then I will talk about several channels
through which the Fed communicates monetary
policy information to the public. One of these
channels—the movement of people in and out of
the Federal Reserve System—really goes both
ways. Another broad channel is speeches and

congressional testimony. A third channel is the
information the Federal Open Market Committee
(FOMC)—the Fed’s chief policy body—releases
in revealing its decisions and deliberations. I will
conclude with some suggestions for improving
communication.
Before proceeding, I want to thank my colleague at the St. Louis Fed, Bill Gavin, for his
extensive work on this speech. However, I retain
full responsibility for errors. The views expressed
are mine and do not necessarily reflect official
positions of the Federal Reserve System.

WHY COMMUNICATION MATTERS
The Federal Reserve implements its monetary policy by setting an intended interest rate
for federal funds. Federal funds are simply reserve
balances owned by banks on deposit at Federal
Reserve Banks. A bank requiring, or desiring,
larger reserve balances may borrow them from
another bank with surplus balances; the interest
rate on these loans is called the “federal funds
rate.” The Open Market Desk at the Federal
Reserve Bank of New York intervenes in the
market to keep the federal funds rate near the
intended rate determined by the FOMC at its
most recent meeting. Most activity in the federal
funds market is for one-day loans—“overnight”
loans, in market parlance. So, Fed policy decisions
determine the interest rate on overnight loans
between banks. How can such decisions affect
the interest rates important to businesses and
households?
The mortgage interest rate, for example, is
extremely important to homeowners, prospective
homeowners, and homebuilders. Where does the
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MONETARY POLICY AND INFLATION

rate on a 25-year, fixed-rate mortgage come from?
Well, the Fed sets the one-day rate. The 1-week
rate depends on market expectations about what
the Fed will do with the one-day rate over the
next seven days. The one-year rate depends on
the market’s expectations for the next 52 1-week
rates. The 25-year mortgage rate depends on the
market’s expectations about the next 25 1-year
rates. Where do all these expectations come from?
They come from the market’s understanding of
what the Fed will do with the 1-day rate on the
average over the next 25 years.
This basic picture, of course, is greatly complicated by changes in the real rate of return on
riskless investments, risk and liquidity differentials, and other factors, but the basic point I want
to emphasize is that longer-term interest rates
depend critically on market expectations about
what the Fed will do, or will have to do, in the
future. And what the Fed does depends critically
on what it has to do to achieve its goal of low and
stable inflation. Although the Fed has substantial
control over the federal funds rate in the short
run, it has no lasting, or long-run, effect on the
average level of rates if it is successful in achieving
price stability. Over the long run, rates depend
on the economic fundamentals of productivity
growth, saving and so forth.
A couple of examples will make clear how
important Fed communication is. Suppose, purely
hypothetically, the Fed believes that economic
conditions are softening and that lower interest
rates are appropriate to the needs of the economy.
Believing that only modest stimulus is required,
the Fed lowers the federal funds rate by 1/4 of a
percentage point. The market, however, might
believe that the rate cut is the first of several cuts.
Based on this belief, the market bids longer-term
rates, including the mortgage rate, down by, say,
1/2 of a percentage point. The Fed finds that the
stimulus to economic activity, including home
building, is greater than intended, and in a few
months the Fed reverses the original rate cut.
Longer-term interest rates rise, and the market is
thoroughly confused about the Fed’s intentions.
Again, purely hypothetically, let’s say the
market interprets the Fed’s initial rate cut as
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temporary. In this case, longer-term rates move
little, if at all. The Fed discovers that it has not
provided enough stimulus to the economy, and
in a few months cuts the federal funds rate again.
Eventually, longer-term interest rates do fall, but
valuable months have been lost. In both examples,
market expectations of future Fed policy clearly
play a central role in the transmission of monetary
policy actions to the economy. It might seem a
simple matter for the Fed to make clear what it
intends to do, but the problem is not at all simple.
The fact is that Fed adjustments of the federal
funds rate in the future depend primarily on
future events that cannot be forecast accurately.
The Fed cannot explain to the market what the
path for the federal funds rate will be because
the Fed itself does not know.
This point is critical: The Fed itself does not
know what the future path of the federal funds
rate will be. What the Fed needs to communicate
to the markets is how it will adjust the funds rate
in response to events, or economic developments,
that cannot be forecast. This communications task
is enormously difficult because so many different
considerations have to be folded into policy decisions. At any given time, there might be six important considerations that point toward policy easing
and four that point toward policy tightening.
The Fed must weigh competing considerations,
take account of data inaccuracies and figure out
whether markets have already responded to this
flow of information, making a Fed response
unnecessary.
In sum, Fed communication is critical to the
effectiveness of monetary policy, but devilishly
difficult, because policy itself is difficult and
because so much depends on an unforecastable
future. The Fed must communicate in an environment in which many key economic issues are
unresolved, in which competing theories vie for
attention and in which listeners’ understanding
ranges widely. So, how does the Fed communicate? Clearly, this whole area is fluid—we are
constantly searching for ways to improve what
we do. But I can provide a progress report.

Communicating the Stance of Monetary Policy

INTERACTION BETWEEN PEOPLE
INSIDE AND OUTSIDE THE FED

SPEECHES AND CONGRESSIONAL
TESTIMONY

An important source of information about
the Fed’s inner workings comes from economists
and policymakers who leave the Fed for the
marketplace. These people are in great demand
because they have special knowledge about how
the Fed works. Many of the economists seen on
business news shows or quoted in the financial
press are former Fed economists. Federal Reserve
governors and Reserve Bank presidents at times
leave the Fed to go to executive positions in the
financial services industry. There are shifts in the
opposite direction as well. The Federal Reserve
System benefits from the practical business experience of the bankers and business people who
come to work as policymakers.
There is also an important interchange
between the academic community and the Federal
Reserve. Many of the governors and some presidents come from the academic community where
they have developed careers doing research on
monetary policy issues. But the information
exchange goes far beyond just an exchange of
personnel. Academic economists are regularly
invited to present their ideas in seminars and Fedsponsored conferences. These national experts
on monetary theory and monetary policy often
spend time at the Board of Governors and Federal
Reserve Banks as visiting scholars. Fed economists
routinely contribute papers at conferences sponsored by academic and private research institutes.
Happily, this extensive interaction between
academic and Fed economists has generated
something of a consensus on monetary policy
goals: While monetary policy may have a variety
of objectives, the overriding long-run objective
should be price stability. There is now substantial
agreement that the Fed can achieve its long-run
policy goal by using the federal funds rate as the
day-to-day guide for open market operations.
Interaction with Fed insiders helps academic
scholars focus on practical issues and helps Fed
economists understand and apply new theories
developed by leading scholars.

The public and markets also learn about how
the Fed works (and how the Fed thinks the world
works) through the speeches of Reserve Bank
presidents and governors of the Federal Reserve
System—that is, those who attend FOMC meetings. These speeches give an indication of the
range of views among FOMC members, their
beliefs about the stage of the business cycle and
their perceptions of the balance of risks between
inflation and unemployment.
The most sought-after speaker is the Chairman
of the Federal Reserve System. At present, the
Chairman is Alan Greenspan, who took office in
1987. The Chairman is the one person within the
Federal Reserve who does not preface his remarks
with a disclaimer saying that his views “are not
necessarily official views of the Federal Reserve
System.” He often uses congressional hearings to
explain his view of the state of the economy and
to review recent policy actions. Written testimony
is carefully prepared, and members of Congress
have extensive opportunity to pursue issues that
concern them during the Q & A part of hearings.
Twice every year for some years, the Fed
Chairman has reported the economic forecasts of
members of the FOMC to Congress. These forecasts
reveal the outlook of the members for growth in
real GDP, nominal GDP, and the CPI measured
from the fourth quarter of one year to the fourth
quarter of the next. The forecast also includes
the outlook for the average unemployment rate
in the fourth quarter of the calendar year. The
Chairman reports the full range of forecasts of
FOMC members, from the lowest to the highest
for each item. He also reports a narrower range
called the “central tendency.” To get this narrower
range, the Board of Governors staff discards the
extreme values. These forecasts are particularly
interesting because monetary policymakers make
them taking into account the policy adopted by
the FOMC.
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MONETARY POLICY AND INFLATION

POLICY ACTIONS TAKEN AT
FOMC MEETINGS
The focal point of every FOMC meeting is
the final vote at the meeting’s end on the intended
federal funds rate. To reach this decision, committee members hear staff briefings, examine data
that have arrived since the last meeting, and deliberate about the appropriate stance of monetary
policy. Deliberations include discussion of the
risks on the upside and downside. Before every
FOMC meeting, Board staff and Reserve Bank
staff brief the governors and Bank presidents on
economic news since the last meeting. These briefings differ among Reserve Banks, depending on
the traditions of each bank and the background
of each bank president. However, every briefing
includes a discussion of what the incoming
news implies for the stance of monetary policy.
The Board staff prepares and circulates regular
briefings and, before each FOMC meeting, the
Greenbook and the Bluebook. The Greenbook is
the forecast of the economy over the next year
or two, and the Bluebook is a summary of open
market operations and developments in financial
markets as well as a discussion of policy options.
FOMC meetings usually begin at 9:00 AM
on a Tuesday morning with presentations to the
Committee from the international and open market
desks of the New York Fed. After a period of discussion, Board staff presents the key elements in
the staff forecast contained in the Greenbook.
Committee members then give their views about
the state of the economy and whether they think
the incoming news has shifted their opinions
about the appropriate stance of monetary policy.
After this first round of discussion, the staff members who prepared the Bluebook give a briefing
on financial markets, the monetary aggregates,
and policy options. There is a second go-around
in which the Committee members state their
views about the stance of monetary policy. The
Committee often discusses at length exactly what
to say publicly about the probable, or possible,
future direction of policy. The aim is always to
figure out the most constructive thing to say to
make policy more effective and not to confuse,
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even inadvertently, the markets. Then a vote is
taken on the key decision variable—the level of
the federal funds rate.
Important information that arrives between
meetings may or may not lead to a change in the
policy setting. In recent years, the Fed has rarely
changed its policy between FOMC meetings.
However, as information arrives day by day, securities’ prices may adjust based on the market’s
view of the likelihood of FOMC action at its next
meeting. If the markets understand the Fed’s
objectives and operations, then they should be
well prepared for the policy action, if one occurs.
How can the markets successfully predict
what the FOMC will do at its next meeting? Part
of the story, of course, is that market participants
carefully follow speeches by FOMC members,
especially the Chairman’s. But a major part of
the story, and a part incompletely appreciated by
most observers, is that the markets already have
a deep understanding of monetary policy. Much
of the time, the Fed and the markets are in close
agreement about what policy actions will be
required to keep the economy on a steady course
in the face of new information.
In an earlier speech, I defined the idea of
policy “perfection” as the situation in which
there is no market reaction to a Fed policy action
because the move was perfectly anticipated. Of
course, this ideal is never achieved because information inside and outside the Fed is not perfectly
synchronized and because people disagree about
how the world works. Since February 1994, the
FOMC has announced changes in the fed funds
target on the same day that the decisions are made.
Six or seven weeks later, a few days after the next
scheduled meeting, the FOMC releases the minutes of the previous meeting. So there is an average
lag of several weeks between the end of the meeting and the release of the minutes. These minutes
disclose the topics discussed, summarize views
about the state of the economy, and describe the
reasons for any dissenting votes. The minutes are
thorough and an important vehicle for keeping
the markets and the general public well-informed
about Fed thinking.

Communicating the Stance of Monetary Policy

OTHER COMMUNICATION
CHANNELS
The Fed has many other communications
channels, which I want to mention just briefly.
Each Fed District Bank has nine directors, and
each branch has seven directors. The directors
are drawn from the private sector and meet
monthly at their Banks and branches. In the
Eighth Federal Reserve District, for example, we
have a total of 30 directors. They gain from their
directors’ meetings and other contacts with the
Fed a body of knowledge that grows with their
service, and they serve as ambassadors, spreading this knowledge throughout their communities.
Each Fed Bank has numerous advisory boards
that meet from time to time with the Bank president and other employees. We have programs in
which we tour our districts, talking with bankers,
business and community leaders, academics, and
others. Many of us have fairly frequent contacts
with members of the press.
I have not tried to count all my contacts over
the course of a year, but I know the total runs to
the thousands. Admittedly, many of these contacts
are with audiences at speeches, but a significant
number are one-on-one or in small groups. These
are contacts involving conversations about monetary policy issues, and I do the best I can to field
all the questions that come my way with forthright
and informative answers.

IMPROVING COMMUNICATIONS
ABOUT THE STANCE OF
MONETARY POLICY
I will conclude by discussing how we might
improve our communication about the stance of
policy. I think enhancing the credibility of policy
is extremely important. It is important to clarify
the long-term policy objective. But for the objective to be credible, it must be consistent with the
economic policy objectives of the legislative and
executive branches of government. There has been
an amazing development in the last decade—the
decline of inflation. A decade ago, hardly anyone

I know would have predicted the degree to which
inflation rates around the world would have converged to such a low level. There is now considerable agreement that price stability should be the
primary objective of monetary policy.
The Fed’s legislative mandate includes multiple objectives: price stability, and full employment—or its equivalent, maximum sustainable
economic growth. At one time, economists
believed that there was a trade off between the
trend rate of inflation and the unemployment
rate. The experience of the 1970s taught us that
higher inflation creates a much less stable economy. Rather than reducing the average level of
unemployment, if anything, higher inflation leads
to higher unemployment and less real growth.
Although consensus has been growing that
price stability should be the primary goal of
monetary policy, the objective remains rather
vaguely defined. We inherited this vagueness
from a time when there was no clear consensus
about the policy objective and when people
believed that the inflation-output trade off was
an important consideration for both short- and
medium-term policy considerations.
Recent research at the Federal Reserve Bank
of St. Louis shows that if there is a short-run
trade off between inflation and resource utilization, the adoption of an operational goal for longterm price stability likely would enhance the
FOMC’s ability to stabilize both output and inflation. What do I mean by an operational goal for
long-term price stability? What I am talking about
is a clarification of the desired inflation objective
over a relatively long planning horizon. In 1999,
we are seeing a rebound of inflation from the
1998 level. Will the Fed view the rebound as the
beginning of a general acceleration or just an offset now that the temporary oil price decline last
year is over? That is, will the Fed view the 1999
rate of inflation as consistent with its long-run
objective or above it? Without the long-term
benchmark, the markets cannot be sure.
To see why clarifying the long-term objective
is important for interpreting the stance of policy,
consider the information problem the market has
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MONETARY POLICY AND INFLATION

to solve when policy is “perfect” and the policy
objective is explicit. Even in this case, because
we still have much disagreement about how the
world works, and cannot predict unforeseen
events, markets will not know for sure how a
given piece of news will affect the short-run path
of inflation or whether it will trigger a change in
the Fed’s policy stance. Opinions about these
short-run matters will differ. But markets will
know the long-term price objective, and the objective will not change because of the news or the
Fed’s short-term reaction to it.
Now suppose that the price stability objective
is vaguely stated. Market participants do not know
whether price stability means 3 percent inflation
in the CPI, as we experienced from 1991 to 1996;
2 percent inflation, as we have seen over the last
three years; or 1 percent CPI inflation, as I would
recommend. In the absence of a precise long-term
objective, markets not only have to figure out how
incoming information affects the short-run path
for inflation and the probability of future FOMC
policy actions, but also must decide how all of
this will affect the long-term objective. When the
long-term policy objective is imprecise, the longterm outcome may be the result of an accumulation of short-run decisions.
The lack of an operational objective might be
thought of as the absence of a nominal anchor.
This absence is one reason why markets and the
general population pay so much attention to shortrun policy actions and seemingly routine speeches
by Fed policymakers. I think one reason why the
Fed received much less attention in the 1950s and
1960s is because the long-term policy objective
was defined by the dollar’s attachment to gold in
the international monetary arrangements made
after World War II. Because of these arrangements,
the public’s estimate of the long-term inflation
rate was not much affected by speeches or shortrun policy actions. In retrospect, the public should
have been paying more attention to those shortrun decisions because they were inconsistent
with the survival of that international monetary
system into the 1970s.
As an aside, I want to take a moment to say
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why I would target a 1 percent growth trend in
the CPI. A few years ago, the Boskin Commission
reported on measurement bias in the CPI. The
commission concluded that the CPI overstated
growth in the true cost of living by 1.1 percentage
points per year. Since then, the Bureau of Labor
Statistics has modified its procedures in a way
that corrects about half of that bias. Advances in
technology have led to new goods and quality
improvements that we cannot measure on a timely
basis. Therefore, in my judgment at this time,
given the findings of the Boskin Commission,
other information and, of course, subject to further research, a 1 percent inflation rate as measured by the CPI is a reasonable approximation to
zero inflation, properly measured. But the actual
number for the inflation target is not nearly as
important as is the decision to choose a particular
number and create a benchmark for making policy
transparent and accountable. We can change
many things to improve our communication
about the stance of policy. At the end of the day,
however, I do not think any of this will make
much difference if the FOMC, the Administration
and the Congress do not find a way to make the
long-term price objective more concrete.
Communication is obviously not a substitute
for the FOMC itself being very clear in its internal
deliberations. I have been following monetary
policy for a long time and believe that the Fed
has made enormous strides in defining and pursuing an effective policy. But there is more to be
done, and improving communications is an area
we’re working on. I hope I’ve provided a good
sense of just how important and how difficult
these issues are. I, for one, would be delighted to
hear from academic and market experts with
ideas as to how we could communicate more
effectively.

SUMMARY
Communication is central to a successful
monetary policy. The Federal Reserve sets the
overnight federal funds rate, leaving all longerterm interest rates to be determined by market

Communicating the Stance of Monetary Policy

forces, the most important of which is the market’s
expectations of future short-term interest rates.
Those expectations, in turn, depend critically on
views concerning future Federal Reserve policy.
I believe that the market has great confidence
that the Fed will keep inflation low and stable,
but more can be done to further strengthen that
confidence. At the top of my agenda in this regard
is for the Fed to be more explicit about its inflation objective—an objective I believe should be
zero inflation, properly measured.
Interest rates will not be perfectly stable if
the Fed is successful in achieving its goal of low
and stable inflation. That should be clear to everyone who has watched market interest rates fluctuate in recent years even though the trend rate of
inflation has changed little. As various economic
developments require interest rate adjustments
to be consistent with low inflation, the Fed must
process incoming information as best it can to
decide when and by how much to adjust the federal funds rate. The better the market understands
how and why the Fed reaches its decisions, the
better it will be able to respond to new information in the same way the Fed responds to the same
information. The result will be a smoother and
more efficient transmission of monetary policy
changes to the economy’s product, labor, and
capital markets.
Improving communication is important, then,
because the Fed and the market both have to deal
with inherently unforecastable events. On many
issues, there are no settled, confirmed theories on
which we can base our actions. Like economists
and market experts everywhere, we naturally
differ among ourselves on such issues. With
important advances in economic science, however, the Fed has gone a long way to narrow the
range of uncertainty. There is a lot to be done,
but we’re working on it.

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