New Challenges for Monetary Policy: A Summary of the Bank's 1999 Symposium

After two decades of successfully restoring price stability in much of the world economy, central banks begin the next millennium facing a new set of challenges. One key task is how to conduct monetary policy in an era of price stability. Clearly, policymakers would like inflation to remain subdued. But, how should monetary policy procedures be designed to ensure that inflation does not reappear as a serious policy problem? Another important question is whether central banks enjoy greater operational flexibility or face new constraints in an environment of low inflation. On the one hand, operating in a low-inflation environment may give central banks greater leeway to address short-run economic problems without compromising long-run price stability. On the other hand, monetary policy implementation may become more difficult as nominal interest rates approach zero. Recent crises in financial markets around the world pose an additional set of challenges for policymakers. Indeed, preserving global financial stability and dealing with extreme asset price and exchange rate movements have taken on greater urgency in many recent policy discussions. To explore the implications of these issues, the Federal Reserve Bank of Kansas City held a symposium titled "New Challenges for Monetary Policy" at Jackson Hole, Wyoming, on August 26-28, 1999. The symposium brought together a crosssection of distinguished experts from central banks, academic institutions, and financial markets from around the world. This article highlights the principal issues raised at the symposium and summarizes the papers presented and the commentary. The first section of the article provides an overview of the main issues and identifies areas of agreement and disagreement among program participants. The remaining sections summarize the viewpoints of the participants and their policy recommendations. 1. SYMPOSIUM HIGHLIGHTS Much of the discussion at the symposium focused on three main issues: the operation of monetary policy in a low-inflation environment, the relationship between asset prices and monetary policy, and the choice of an exchange rate system. While there was considerable consensus among participants on each of these issues, there were also some significant areas of disagreement. On the issue of monetary policy in a low-inflation environment, all participants agreed that success in maintaining low inflation required central banks to maintain a credible commitment to price stability. There was less unanimity, however, on how to accomplish this goal. One area where differences emerged was the appropriate definition of price stability. Although most participants favored defining price stability in terms of an inflation rate, there was some support for looking more closely at the advantages of pricelevel targeting rather than inflation-rate targeting. Participants also debated how inflation targets should be defined. Generally speaking, those advocating inflation targets above zero justified their position by citing measurement errors in inflation indexes and possible constraints on monetary policy in a low-inflation environment, principally, downward nominal wage rigidity and a zero bound on nominal interest rates. Participants who found these arguments unconvincing preferred an inflation target set at zero. There was also considerable discussion, and disagreement, on how monetary policy should be implemented in a low-inflation environment. Important issues raised included: what information policymakers should respond to in altering the stance of policy, the short-run tradeoff between inflation variability and output variability, whether policy should be preemptive, and the relative merits of rule-based vs. discretionary policy adjustments. Participants also debated whether a "liquidity trap" could limit the ability of a central bank to conduct monetary policy in a low-inflation environment. Thus, in the case of Japan, where short-term nominal interest rates are currently near zero, some participants felt there was little scope for traditional monetary policy measures in stimulating the economy. …