- The Washington Times - Saturday, October 23, 2004

Of late, Federal Reserve governors and bank presidents have been talking a lot about Fed transparency. How open the Fed should be has always been a touchy subject, and one can only wonder if the latest talk is a hint of things to come.

Over the past decade, the Fed — and more particularly its Federal Open Market Committee (FOMC) — has made great strides in opening up to the public. There was a time when mystery and secrecy were Fed hallmarks, and openness about policy decisions was thought by some to be detrimental to the economy.

In 1988, Fed Chairman Alan Greenspan was quoted as saying: “Since I have become a central banker, I have learned to mumble with greater coherence.” But it was under Mr. Greenspan’s watch that the Fed lost its opaqueness. The minutes and transcripts of FOMC meetings have been made available to the public, albeit with a lag, and immediately following each meeting a news release is issued announcing the short-term federal funds rate target along with an explanation and a statement of likely future policy. As a consequence, public understanding of monetary-policy decisions and goals has been greatly enhanced.

But does Fed transparency have limits? Can there be too much of a good thing? Or should there be more? Economists, including Fed officials, differ in their views.

Chairman Greenspan has opposed having FOMC meetings televised or open to the press, and understandably so. Debate and the free flow of ideas would inevitably be constrained and do injury to the policy process.

Some economists are concerned that beyond some point openness could be more confusing than helpful. They worry that the public could be overloaded with technical information and point to the difficulty of explaining the complex models and judgments that underlie Fed policy-making. They question the wisdom of making public the possibly divergent numerical economic forecasts of individual FOMC members and the Fed staff. Some fear that making available more information about policy changes could create expectations that lead to more volatile inflation and interest rates. Market participants might overreact to new information. Some argue that the Fed works against itself by making known its intentions, that monetary policy is more effective when markets are taken by surprise. Optimal transparency, some say, is less than total transparency.

Advocates of transparency believe that well-informed markets work better. The absence of surprise, they argue, has a calming effect. It helps markets digest interest rate changes and is more likely to result in steady economic growth and low inflation. Fed openness helps convince markets that inflation will remain in check, leading to restraint in wage and price setting, which also makes life easier for the Fed. With less uncertainty, forecasting becomes more accurate and improves decision-making. When Fed policy is better anticipated, the economy reacts to it sooner. Not least, the Fed has a public obligation to be open and communicative.

One form of transparency not yet adopted by the FOMC has been particularly controversial — inflation targeting. It involves announcing to the public an explicit numerical inflation target, either a single number or a range. The target period would be medium or long term, leaving maneuvering room for the FOMC in the short run. Since 1990, the central banks of many countries have adopted inflation targeting, but a majority of the FOMC apparently has yet to be convinced of its effectiveness. Chairman Greenspan is on record as opposing targeting, saying “a specific numerical inflation target would represent an unhelpful and false precision.”

Opponents think inflation targeting is too mechanical and would limit policy flexibility and discretion. They point out that targeting only inflation carries the risk of subordinating the Fed’s objective of achieving high levels of output and employment. Advocates believe targeting is a more systematic approach that would help maintain price stability and promote steady economic growth.

Mr. Greenspan, who has strong credibility as an inflation fighter, will be leaving the Fed when his term expires at the end of January, 2006. Institutionalizing inflation targeting could help convince potentially jittery markets that the Fed will continue to strive for price stability.

Recently, two Fed officials, Gov. Ben S. Bernanke and Philadelphia Fed Bank President Anthony Santomero, have spoken in favor of inflation targeting. In a speech on Oct. 7, Mr. Bernanke said: “It’s my own view that we are approaching the limits of purely qualitative communication and should consider the inclusion of quantitative information presented in a clearly specified framework. For example, like policy-makers at many other central banks, the FOMC could specify its long-term inflation objective and include explicit economic forecasts, conditioned on alternative assumptions, in its statements or in regular reports.” (At present the Fed makes public numerical forecasts limited to one year ahead, only twice annually, and for only gross domestic product, core prices and the unemployment rate.)

Three days earlier, Mr. Santomero, speaking to business economists in Philadelphia, recommended a specific inflation targeting proposal: “The Fed should establish a target band of 1 to 3 percent for annual inflation, as measured by the 12-month moving average rate of change in the core PCE [personal consumption expenditure] deflator.” (I would not exclude energy prices, as the core PCE price measure does, since oil and other energy prices are establishing a separate trend from other prices, emitting more signal than noise. Using a moving average should be enough to dampen any unwanted short-term variations in energy prices, and the important energy signal would be retained.)

St. Louis Fed President William Poole is also on record as favoring inflation targeting, stating a preference that the target be legislated.

Fed Gov. Edward M. Gramlich, speaking in Canada last year, said: “If we were to move in the direction of a more systematic approach, I personally would go to a preferred range for inflation rather than a particular target.” The long-run range that he named was from slightly above 1 percent to about 2.5 percent a year for the core PCE price index.

For the time being, it seems unlikely that the FOMC will adopt inflation targeting, at least as long as Mr. Greenspan is at the helm. But, as Mr. Bernanke said, the Fed may be close to exhausting its non-quantitative messaging. If evidence accumulates from research and experience abroad that inflation targeting yields net benefits to policy, then the Fed will have to reconsider its position. Once Mr. Greenspan has left, it’s likely the issue will be moved to the front burner.

Alfred Tella is a former Georgetown University research professor of economics.

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