Ben S Bernanke: Federal Reserve communications
Speech by Mr Ben S Bernanke, Chairman of the Board of Governors of the US Federal
Reserve System, at the Cato Institute 25th Annual Monetary Conference, Washington DC,
14 November 2007.
* * *
The more fully the public understands what the function of the Federal
Reserve System is, and on what grounds its policies and actions are
based, the simpler and easier will be the problems of credit administration
in the U.S.
- Federal Reserve Board, Annual Report, 1923, p. 95.
Montagu Norman, the Governor of the Bank of England from 1921 to 1944, reputedly took as
his personal motto, "Never explain, never excuse." Norman's aphorism exemplified how he
and many of his contemporaries viewed the making of monetary policy - as an arcane and
esoteric art, best practiced out of public view. Many central bankers of Norman's time (and,
indeed, well into the postwar period) believed that a certain mystique attached to their
activities and that allowing the public a glimpse of the inner workings would only usurp the
prerogatives of insiders and reduce, if not grievously damage, the effectiveness of policy.
Norman's perspective on central banking now seems decidedly quaint. Over the past few
decades, central banks around the world have worked assiduously to become more open
about their activities. In fact, Norman's own institution, the Bank of England, has in recent
years been a leading exponent of increased transparency in central banking. Monetary policy
makers have adopted a range of methods to improve their communication with the public,
including timely announcements of policy actions, expanded testimony before members of
the legislature, the release of minutes of policy meetings, frequent public speeches, and the
regular publication of reports about the economy and monetary policy. This increased
openness is a welcome development for several reasons. Most importantly, monetary policy
makers are public servants whose decisions affect the life of every citizen; consequently, in a
democratic society, they have a responsibility to give the people and their elected
representatives a full and compelling rationale for the decisions they make. Good
communications are a prerequisite if central banks are to maintain the democratic legitimacy
and independence that are essential to sound monetary policy making.
In addition, a considerable amount of evidence indicates that central bank transparency
increases the effectiveness of monetary policy and enhances economic and financial
performance in several ways. First, improving the public's understanding of the central bank's
objectives and policy strategies reduces economic and financial uncertainty and thereby
allows businesses and households to make more-informed decisions. Second, if practitioners
in financial markets gain a better understanding of how policy is likely to respond to incoming
information, asset prices and bond yields will tend to respond to economic data in ways that
further the central bank's policy objectives. For example, if market participants understand
that arriving information about the economy increases the likelihood of certain policy actions,
then market interest rates will tend to move in a way that reinforces the expected actions,
effectively supporting the goals of the central bank. Third, clarity about the central bank's
policy objectives and strategy may help anchor the public's long-term inflation expectations,
which can substantially improve the efficacy of policy and the overall functioning of the
economy. Finally, open discussion of the central bank's analyses and forecasts invites
valuable input and feedback from the public.
The benefits of an open and accountable policymaking process have spurred the Federal
Reserve, along with other major central banks, to take a number of actions over the years to
increase its transparency. Appropriately, given the unique position of the Federal Reserve
and the sensitivity of financial markets to its communications, these steps have generally
been incremental in nature; but, taken together, they have substantially increased the ability
of the American public to understand and to anticipate monetary policy decisions.
The Congress has also long been aware of the importance of Federal Reserve transparency
and accountability; in particular, a series of resolutions and laws passed in the 1970s set
clear policy objectives for the Federal Reserve and required it to provide regular reports and
testimony to the Congress.1 Since 1975, the Federal Reserve has presented testimony twice
each year to the Congress on the conduct of monetary policy. These semiannual
presentations have become an important vehicle for the U.S. central bank to make known its
views on the outlook and on the appropriate stance of policy. Other notable milestones in the
Federal Reserve's progress toward greater openness include: in 1979, the first release of
semiannual economic projections; in 1983, the first publication of the Beige Book, which
summarizes information about economic conditions received from the Federal Reserve
System's business contacts; in 1994, the decision to release a postmeeting statement when
policy actions had been taken; in 2000, the beginning of the practice of issuing a statement
after each meeting of the Federal Open Market Committee (FOMC) and including in the
statement an assessment of the balance of risks to the Committee's objectives; in 2002,
adding the FOMC roll call vote to the postmeeting statement; and in 2005, the speeding up of
the release of the minutes of FOMC meetings, from a delay of some six or seven weeks to
just three weeks.
In testimony to the Congress at the time of my nomination as Chairman, in 2005, I pledged to
continue the trend toward greater openness sustained under Chairman Greenspan. In so
doing, I stressed the importance of continuity with the policies and strategies that have
served the American economy well. Any further changes, I promised, would come only
pursuant to a consensus within the FOMC that those changes would enhance the
Committee's ability to pursue its dual mandate of achieving maximum employment and price
stability.
Toward that end, the FOMC has engaged in extensive deliberations over the past year or so
to consider further steps toward greater transparency. Guided by a subcommittee chaired by
Board Vice Chairman Donald Kohn, the FOMC reviewed the full range of our
communications with the public.2 As indicated in a statement issued by the FOMC today,
these discussions have led to a decision to increase the frequency and expand the content of
the publicly released economic projections that are made by Federal Reserve Board
members and Reserve Bank presidents. As I mentioned, the Federal Reserve has published
economic projections for almost thirty years, and, indeed, the Federal Reserve was the first
major central bank to release such projections.3 Today's announcement builds on that
foundation. In the remainder of my remarks I will describe the changes that we plan to make,
and then explain why I believe that, collectively, they represent an important further step
toward greater transparency.
Toward more informative economic projections
Because monetary policy affects spending and inflation with a lag, policy decisions must be
based on an assessment of medium-term economic prospects. Thus, the Committee cannot
fully explain its policy decisions without sharing its economic outlook with the public and the
Congress. To provide more-timely information about the evolving outlook, the Federal
Reserve will release FOMC participants' economic projections four times each year, rather
than twice each year as we have done previously.
Projections will continue to be released in February and July of each year to coincide with the
semiannual Monetary Policy Report and the associated testimony to the Congress. Two
additional sets of projections will be published in conjunction with the minutes of the FOMC
meetings held around the beginnings of the second quarter and the fourth quarter of the year
(in 2008, the April and October meetings). The first expanded set of projections will be
released next week, on November 20, together with the minutes of the October FOMC
meeting. The horizon of the projections will be extended from two years to three. The
projections released next week will extend through 2010.4
Each of the participants in the FOMC meeting - including the Federal Reserve Board
members and all the Reserve Bank presidents - will, as in the past, provide projections for
the growth of real gross domestic product (GDP), the unemployment rate, and core inflation
(that is, inflation excluding the prices of food and energy items). In addition, participants will
now provide their projections for overall inflation. Both overall and core inflation will continue
to be based on the price index for personal consumption expenditures (PCE).5
Projections will continue to be made independently by each FOMC participant under the
assumption of "appropriate" monetary policy, that is, the future evolution of the federal funds
rate judged by that participant to be the one most likely to foster economic outcomes that
satisfy the Federal Reserve's dual mandate. Following past practice, we will publish the
central tendency and the range of the projections for each variable and each year.6 We will
also publish a comparison with the previous set of quarterly projections; a chart showing
central tendencies and ranges for each variable; and charts showing the distribution of
participants' projections and how that distribution has changed since the previous release.
Accompanying the numerical projections will be a discussion - a projections "narrative" if you
will - that summarizes participants' views of the major forces shaping the outlook, discusses
the sources of risk to that outlook, and describes the dispersion of views among
policymakers. By providing a medium-term perspective, the narrative will complement the
discussion of shorter-term developments contained in the minutes. We will also provide
qualitative information about participants' views on both the uncertainty and the balance of
risks surrounding the outlook, together with quantitative historical information on the typical
range of projection errors.7 Of course, the specific material provided and its form of
presentation may change over time as we gain experience and receive feedback.
4
The projection period of the first three releases each year will cover the current year and the subsequent two
years. The fourth release each year will add a year to the projection horizon. Thus, the first three sets of
projections in 2008 will be for the period 2008 through 2010, whereas the fourth set of projections will extend
to 2011.
5
Participants will no longer provide projections for the growth of nominal GDP. These now seem relatively less
useful to the public, given participants' projections for real GDP growth and overall inflation.
6
The range for each variable in a given year includes all participants' projections, from lowest to highest, for
that variable in the given year. The central tendencies exclude the three highest and three lowest projections
for each variable in each year.
7
A Board staff paper discussing the historical forecasting record of the Federal Reserve and other institutions
will be released on November 20, simultaneously with the release of the expanded projections.
BIS Review 132/2007
Benefits of the enhanced projections
The enhanced projections will provide the public with several types of useful information. In
particular, I find it helpful to think of the projections as functioning in three different ways: as a
forecast, as a provisional plan, and as an evaluation of certain long-run features of the
economy.
Most obviously, the projections reflect the economic forecasts of FOMC participants and as
such should provide the public with greater and more-timely insight into the Committee's
views of the economic outlook and the risks to that outlook. Of course, because our
knowledge of the structure of the economy is incomplete and future economic disturbances
are often unforeseeable, economic forecasting is a highly uncertain enterprise.8 The only
economic forecast in which I have complete confidence is that the economy will not evolve
along the precise path implied by our projections. Nevertheless, as I have already noted,
because policy affects spending and inflation with a lag, Committee members have no choice
other than to make medium-term forecasts - provisional and subject to uncertainty though
they may be. Providing more information about these forecasts, including discussions of the
factors underlying the forecasts and of FOMC participants' assessments of the risks to the
Committee's objectives, should improve the public's understanding of the rationale for the
current stance of monetary policy and any changes to that stance. The public will also be
better able to judge the extent to which the Committee's rationale is reasonable and
persuasive.
The projections also function as a plan for policy - albeit as a rough and highly provisional
one. As I mentioned earlier, FOMC participants will continue to base their projections on the
assumption of "appropriate" monetary policy. Consequently, the extended projections will
provide a sense of the economic trajectory that Committee participants see as best fulfilling
the Federal Reserve's dual mandate, given the initial conditions and the constraints posed by
the structure of the economy. To illustrate, consider the question of the length of time over
which a central bank should aim to restore price stability following an unwanted increase in
inflation. A central bank that places weight on both employment and price stability, like the
Federal Reserve, would not attempt to disinflate immediately or establish a fixed time frame
for the restoration of price stability. Rather, the optimal expected time required for completing
the disinflation would depend on a host of factors, including the size of the initial deviation
from price stability, the initial state of the real economy (for example, the level of
unemployment), whether the rise in inflation resulted from transitory or more persistent
sources, the extent to which inflation expectations are well anchored, and so on. In
circumstances in which disinflationary policy is necessary, the extended economic
projections would make clear that the Federal Reserve is committed to maintaining price
stability, but they would also provide some indications about what the Committee views as
the most appropriate pace of disinflation, given the state of the economy and the
requirements of the dual mandate. In like fashion, the speed at which policy aims to return
the economy to its sustainable rates of growth and employment following a period of
resource slack should depend in part on the nature and extent of inflation risks, among other
considerations. More generally, the extended projections will convey additional information
about the Committee's policy strategies and thus help augment the Committee's
transparency, predictability, and accountability.
Finally, the extended projections will embody information about FOMC participants'
evaluations of certain long-run features of the economy, evaluations determined both by the
economy's structure and by the Committee's policy objectives. Because of the extension of
the projection horizon to three years, participants' inflation projections will convey more
information regarding their views about the measured rate of inflation that, in the long run, is
consistent with the Committee's dual objectives of maximum employment and price stability.
Were price stability the only objective mandated for the Federal Reserve, the FOMC
presumably would strive to achieve zero inflation, properly measured - that is, the optimal
measured inflation rate would deviate from zero on average only by the amount of the
estimated measurement error in the preferred inflation index. But under the Federal
Reserve's dual mandate, the determination of the appropriate long-run inflation rate must
take account of factors that may affect the efficient functioning of the economy at very low
rates of inflation, such as the risk that the zero lower bound on nominal interest rates might
hinder the effectiveness of monetary policy. Thus, the (properly measured) long-run inflation
rate that best promotes the dual mandate is likely to be low but not zero.
Ultimately, households and businesses care about the overall, or "headline," rate of inflation;
therefore, the FOMC should refer to an overall inflation rate when evaluating whether the
Committee has met its mandated objectives over the long run. For that reason, the
Committee has decided to publish projections for overall inflation as well as core inflation. In
its policy statements and elsewhere, the Committee makes frequent reference to core
inflation because, in light of the volatility of food and energy prices, core inflation can be a
useful short-run indicator of the underlying trend in inflation. However, at longer horizons,
where monetary policy has the greatest control over inflation, the overall inflation rate is the
appropriate gauge of whether inflation is at a rate consistent with the dual mandate.
FOMC participants will continue to couch their inflation projections in terms of PCE inflation,
rather than, say, inflation as measured by the consumer price index, because the PCE index
is generally thought to provide the single most comprehensive and theoretically compelling
measure of consumer prices. That said, no single measure of inflation is perfect, and the
Committee will continue to monitor a range of measures when forming its view about inflation
prospects.
The lengthening of the projection horizon will also allow the public to infer more about FOMC
participants' current judgments about the rate of GDP growth and the unemployment rate
that the economy can sustain in the long run. Over time, effective monetary policies foster
rates of growth and unemployment close to their long-run sustainable rates. However, in
contrast to inflation, which in the long run is determined by monetary policy, the rates of
economic growth and unemployment that can be sustained in the long run are determined by
many factors outside the control of central banks. Among these factors are the advance of
technology, entrepreneurial activities, the growth in the size of the labor force, the rate at
which workers acquire new skills, tax and regulatory policies, and the efficiency of labor
markets in matching workers with positions. Consequently, the long-run sustainable rates of
economic growth and unemployment should be viewed as constraints on what monetary
policy can achieve and not as variables that policymakers can freely choose. In addition,
estimates of sustainable rates of growth and unemployment have been shown to be highly
uncertain at any point in time; and they may vary significantly over time in light of new
information and changes in the structure of the economy. Thus, the longer-run projections of
growth and unemployment should be treated with considerable caution.
Relationship to inflation targeting
As you may know, I have been an advocate of the monetary policy strategy known as
inflation targeting, used in many countries around the world. Inflation targeting is
characterized by two features: an explicit numerical target or target range for inflation and a
high degree of transparency about forecasts and policy plans. The steps being taken by the
Federal Reserve, I must emphasize, are intended only to improve our communication with
the public; the conduct of policy itself will not change. Nonetheless, in light of the changes to
communications we are undertaking, one might fairly ask how the Federal Reserve's
approach relates to inflation targeting.
A superficial drawback of inflation targeting is its very name, which suggests a single-minded
focus on inflation to the exclusion of other goals. In fact, the practice of monetary policy in an
inflation-targeting regime is not necessarily inconsistent with a dual mandate such as that
given to the Federal Reserve; indeed, most if not all inflation-targeting central banks today
practice "flexible" inflation targeting, meaning that they take account of other economic goals
besides price stability - notably economic growth, employment, and financial stability - when
making policy decisions. Moreover, a broad consensus exists among central banks, whether
they have an explicit numerical target for inflation or not, that maintaining low and stable
inflation over time is the best means by which monetary policy can promote economic
efficiency and maximize the nation's economic welfare. Thus, at least since the stabilization
of U.S. inflation in the 1980s, the Federal Reserve's approach to monetary policy has had
much in common with that of central banks that describe themselves as inflation targeters.
Nevertheless, some aspects of inflation targeting may be less well suited to the Federal
Reserve's mandate and policy practice. In particular, although inflation-targeting central
banks certainly pay attention to economic growth and employment, their formal accountability
is often largely couched only in terms of a price-stability objective. Likewise, the
communication strategies of inflation-targeting central banks tend to be focused on the
formal inflation objective and the horizon over which that objective will be achieved. As I have
emphasized today, the Federal Reserve is legally accountable to the Congress for two
objectives, maximum employment and price stability, on an equal footing. My colleagues and
I strongly support the dual mandate and the equal weighting of objectives that it implies. Of
course, as I have discussed, the Federal Reserve's influence over these objectives differs
importantly in the long run: Monetary policy determines the long-run inflation rate, whereas
the factors that influence the sustainable rates of growth and employment in the long run are
largely outside the central bank's control. Still, over time, monetary policy must strive to foster
rates of growth and employment close to their long-run sustainable rates. The Federal
Reserve must thus be accountable for the effects of its policies on the real economy as well
as on inflation. The enhanced projections that I have described today will provide additional
information pertinent to both halves of the Federal Reserve's mandate.
At a more technical level, the Federal Reserve differs from most inflation-targeting central
banks in that it provides information about the independent projections of Committee
members rather than a single collective forecast. To some extent, that difference reflects the
relatively large size of the FOMC and the geographic dispersion of Committee participants;
those factors would make the development of a detailed consensus forecast quite difficult as
a practical matter. But, as I will discuss briefly, such a diversity of viewpoints can enhance
the quality of policy decisions.
The diversity of the Committee
An important strength of the Federal Open Market Committee is its diversity. The Board
members and Reserve Bank presidents who sit around the table at each meeting of the
FOMC bring a wide range of perspectives to the deliberations that reflect the participants'
professional backgrounds, the regions of the country with which they are most familiar, and
their differing approaches to economic and policy analysis. The task participants face at each
meeting is to forge a rough consensus regarding the outlook, the risks to the Committee's
objectives, and the appropriate policy response. Of course, it is not always possible - indeed,
it would be rather unusual - to come to a set of conclusions that fully represent the views of
every participant. But the process of searching for common ground is itself an important
aspect of how the Committee operates. Diversity of views drives the Committee to adopt an
eclectic approach and thus serves to limit the risk that a single viewpoint or analytical
framework might become unduly dominant.
The changes to the projections process announced today preserve the important role played
by this diversity of perspectives. As I have noted, Committee participants will continue to
produce individual projections that reflect their judgments about the state of the economy and
their approaches to policy. From the internal perspective, I expect the more frequent sharing
of projections and the additional information they contain will improve our discussions and
policy debates. From the external perspective, the public will gain additional and more
frequent information about both the central tendencies and diversity of participants' views. In
particular, the additional narrative material that will accompany the numerical projections will
illuminate both the consensus of opinion and the differences in judgments that may emerge.
Conclusion
The communications strategy of the Federal Reserve is a work in progress. I believe that the
changes announced by the FOMC today are an important advance: The changes will provide
a more-timely insight into the Committee's outlook, will help households and businesses
better understand and anticipate how our policy decisions respond to incoming information,
and will enhance our accountability for the decisions we make. But the changes are also
evolutionary, in that they build on long-established practices; in that respect, they represent
just one more step on the road toward greater transparency at the Federal Reserve. The
Committee will continue to look for ways to improve the accountability and public
understanding of U.S. monetary policy making.