Janet L Yellen: Communication in monetary policy
Speech by Ms Janet L Yellen, Vice Chair of the Board of Governors of the Federal Reserve
System, at the Society of American Business Editors and Writers 50th Anniversary
Conference, Washington DC, 4 April 2013.
* * *
Thank you for inviting me here and for offering me what I consider a perfect opportunity to
speak on a topic at the heart of the Federal Reserve's efforts to promote a stronger economy
- the vital role and growing use of communication in monetary policy.1
Some of you cover the Federal Reserve and are familiar with how it sets monetary policy
through the Federal Open Market Committee (FOMC). You know that the FOMC pays very
close attention to what it says in the statements it issues after each meeting. This
communication is supplemented by Chairman Bernanke's postmeeting press conferences
and by providing detailed minutes of the Committee's meetings. Getting this message out to
the public depends a good deal on the work you do in reporting on the FOMC, analyzing its
statements and actions, and explaining its role and objectives. So let me begin by thanking
you for those contributions.
But let me also say why I am particularly pleased to speak to you today. As writers and
editors, all of you are prodigious consumers and producers of communication. At first glance,
the FOMC's communication may not seem so different from what you've heard other
government agencies say about their policies or businesses say about their products. I hope
to show how communication plays a distinct and special role in monetary policymaking.
Let me offer a comparison that may highlight that difference. Suppose, instead of monetary
policy, we were talking about an example of transportation policy - widening a road to ease
traffic congestion. Whether this road project is announced at a televised press conference or
in a low-key press release - or even if there is no announcement - the project is more or less
the same. The benefit to drivers will come after the road is widened and won't be affected by
whether drivers knew about the project years in advance.
At the heart of everything I'll be explaining today is the fact that monetary policy is different.
The effects of monetary policy depend critically on the public getting the message about what
policy will do months or years in the future.2
To develop this idea, I will take you on a tour of past FOMC communication, the present, and
what I foresee for the future. Until fairly recently, most central banks actively avoided
communicating about monetary policy. Montagu Norman, governor of the Bank of England in
the early 20th century, reputedly lived by the motto "never explain, never excuse," and that
approach was still firmly in place at the Federal Reserve when I went to work there as a staff
economist in 1977.
I'll begin by discussing how a growing understanding of the importance of transparency
shaped FOMC communication in the years before the financial crisis. Next, I'll relate how the
financial crisis brought unprecedented challenges for monetary policy that required the use of
unconventional policy tools, including some barely contemplated before the crisis.
Communication was a centerpiece of these efforts. Finally, I'll look ahead. I am encouraged
by recent signs that the economy is improving and healing from the trauma of the crisis, and I
expect that, at some point, the FOMC will return to a more normal approach to monetary
policy. At the conclusion of my remarks, I'll discuss the communication challenges the FOMC
will face when it comes time to make that transition.
FOMC communication has long been a topic of great interest to me, and one I have worked
on more directly since 2010, when Chairman Bernanke asked me to lead a new FOMC
subcommittee on communications. This is probably a good moment to remind you that, as
always, I speak for myself and not the FOMC or my colleagues in the Federal Reserve
System.
From "never explain" to transparency
Recently I used the word "revolution" to describe the change from "never explain" to the
current embrace of transparency in the FOMC's communication.3 That might sound
surprising to an audience that knows very well what it feels like to be in the middle of a
communications revolution. The speed and frequency of most communication, it seems,
never stops growing, and I will admit that the FOMC's changes to the pace and form of its
communication seem rather modest in comparison. I've mentioned the Chairman's quarterly
postmeeting press conferences, which were initiated two years ago. While these events are
televised and streamed live, the mode for most of the FOMC's communication is decidedly
old-school - the printed word. The Committee's most watched piece of communication is the
written statement issued after each of its meetings, which are held roughly every six weeks.
It may seem quaint that my colleagues and I continue to spend many hours laboring over the
few hundred words in this statement, which are then extensively analyzed only minutes after
their release.
The revolution in the FOMC's communication, however, isn't about technology or speed. It's
a revolution in our understanding of how communication can influence the effectiveness of
monetary policy.
It will help if I start with some basics. The FOMC consists of the 7 members of the Federal
Reserve Board in Washington and 5 of the 12 presidents of the regional Federal Reserve
Banks. All 12 presidents participate in FOMC meetings but only 5 get a vote, a roster that
rotates each year.
The FOMC's job, assigned by the Congress, is to use monetary policy to promote maximum
employment and stable prices, objectives that together are known as the Federal Reserve's
dual mandate. In normal times, the Committee pursues these goals by influencing the level
of a short-term interest rate called the federal funds rate, which is what banks charge each
other for overnight loans. When the FOMC pushes the federal funds rate up or down, other
short-term interest rates normally move in tandem. Medium- and longer-term interest rates,
including auto loan rates and mortgage rates, generally adjust also, through a mechanism I
will return to in a moment. By pushing the federal funds rate up or down, the FOMC seeks to
influence a wide range of interest rates that matter to households and businesses.
Typically, the FOMC acts to lower the federal funds rate, with the intention of reducing
interest rates generally, when the economy is weakening or inflation is declining below the
Committee's longer-run objective. The FOMC raises the federal funds rate when inflation
threatens to rise above its objective or when economic activity appears likely to rise above
sustainable levels. Raising and lowering the federal funds rate was long the primary means
by which the FOMC pursued its economic objectives.
It is hard to imagine now, but only two decades ago, the Federal Reserve and other central
banks provided the public with very little information about such monetary policy moves - the
spirit of "never explain" was very much alive. There were a number of different justifications
for this approach. One view was that less disclosure would reduce the risk and tamp down
suspicions that some could take advantage of disclosures more readily than others. Some
believed that markets would overreact to details about monetary policy decisions. And there
was a widespread belief that communicating about how the FOMC might act in the future
could limit the Committee's discretion to change policy in response to future developments.
In sum, the conventional wisdom among central bankers was that transparency was of little
benefit for monetary policy and, in some cases, could cause problems that would make
policy less effective.
While communication and transparency steadily increased elsewhere in government and
society, change came slowly to the FOMC. It wasn't until February 1994 that the Committee
issued a postmeeting statement disclosing a change in monetary policy. Even then, it only
alerted the public that the Committee had changed its policy stance, with scant explanation.4
Something big was changing, however, and it would soon be the force driving major
enhancements in the FOMC's communication. By the early 1990s, a growing body of
research challenged widespread assumptions about the how central banks, such as the
Federal Reserve, affected the economy. The reevaluation starts with a question that puzzled
many of my students when I was a professor: How is it that the Federal Reserve manages to
move a vast economy just by raising or lowering the interest rate on overnight loans by 1/4 of
a percentage point?
The question arises because significant spending decisions - expanding a business, buying
a house, or choosing how much to spend on consumer goods over the year - depend on
expectations of income, employment, and other economic conditions over the longer term, as
well as longer-term interest rates. The crucial insight of that research was that what happens
to the federal funds rate today or over the six weeks until the next FOMC meeting is relatively
unimportant. What is important is the public's expectation of how the FOMC will use the
federal funds rate to influence economic conditions over the next few years.5
For this reason, the Federal Reserve's ability to influence economic conditions today
depends critically on its ability to shape expectations of the future, specifically by helping the
public understand how it intends to conduct policy over time, and what the likely implications
of those actions will be for economic conditions. To return to the example I used earlier,
contrast this effect on expectations with that of a road project. Today's commute, alas, will
not be improved or changed at all by the news that a road will be widened one day. But the
effects of today's monetary policy actions are largely due to the effect they have on
expectations about how policy will be set over the medium term.
Let me further illustrate this with some history. Starting in the mid-1960s, the Federal
Reserve didn't act forcefully in the face of rising inflation, and the public grew less certain of
the central bank's commitment to fighting inflation. This uncertainty led expectations of future
inflation to become "unanchored" and more likely to react to economic developments. In
1973, an oil price shock led to a large increase in overall inflation. Expectations of higher
inflation in the future affected the public's behavior - workers demanded raises, and
businesses set prices and otherwise acted in anticipation of higher costs - and this helped
fuel actual inflation. The FOMC's occasional efforts to reduce inflation in the 1970s were
ineffective partly due to the expectation that it ultimately wouldn't do enough.
By contrast, most of you probably know about the Federal Reserve's successful inflation
fighting in the early 1980s. The FOMC raised the federal funds rate very high, causing a
deep recession but also convincing the public that it was committed to low and stable
inflation. Anchoring inflation expectations at low levels helped ensure that jumps in
commodity prices or other supply shocks would not generate persistent inflation problems.
This was illustrated by the effect of another escalation in oil prices starting in 2005. Unlike in
the 1970s, these price shocks did not result in a broad and lasting increase in overall inflation
because the public believed the Federal Reserve would keep inflation in check. The FOMC
wasn't forced to raise interest rates - which softened the blow of higher fuel costs on
households and businesses - because of the credibility the Federal Reserve had built since
the 1980s.
If the public's expectations have always been important, you might wonder how monetary
policy had any effect prior to the transparency revolution. As it turns out, with the notable
exception of the late 1960s and 1970s, the FOMC usually responded in a systematic way to
economic conditions. In 1993, economist John Taylor documented that FOMC policy
changes since the mid-1980s had fairly reliably followed a simple rule based on inflation and
output. Changes in the federal funds rate were usually made in several small steps over a
number of months. In practice, the Federal Reserve's approach was "never explain, but
behave predictably."
A close analysis of the FOMC's past behavior was a good guide to future policy, but it had
two shortcomings as a substitute for transparency: First, it gave an advantage to
sophisticated players who studied the FOMC's behavior - something that is arguably
inappropriate for a government institution. Second, while a policy rule such as the one
developed by John Taylor explained the course of the federal funds rate much of the time,
there were cases when it didn't and when even the experts failed to correctly anticipate the
FOMC's actions.
The trend toward greater transparency accelerated during the early 2000s. Starting in 2000,
the FOMC issued information after every meeting about its economic outlook. It also
provided an assessment of the balance of risks to the economy and whether it was leaning
toward increasing or decreasing the federal funds rate in the future. Such information about
intentions and expectations for the future, known as forward guidance, became crucial in
2003, when the Committee was faced with a stubbornly weak recovery from the 2001
recession. It had cut the federal funds rate to the very low level of 1 percent, but
unemployment remained elevated, and the FOMC sought some further way to stimulate the
economy. In this situation, it told the public that it intended to keep the federal funds rate low
for longer than might have been expected by adding to its statement that "[i]n these
circumstances, the Committee believes that policy accommodation can be maintained for a
considerable period."6
Let's pause here and note what this moment represented. For the first time, the Committee
was using communication - mere words - as its primary monetary policy tool. Until then, it
was probably common to think of communication about future policy as something that
supplemented the setting of the federal funds rate. In this case, communication was an
independent and effective tool for influencing the economy. The FOMC had journeyed from
"never explain" to a point where sometimes the explanation is the policy.
By the eve of the recent financial crisis, it was established that the FOMC could not simply
rely on its record of systematic behavior as a substitute for communication - especially under
unusual circumstances, for which history had little to teach. I think we're all fortunate that
policymakers had learned this lesson, because the FOMC was about to encounter
unprecedented economic conditions and policy challenges. The financial crisis and its
aftermath demanded advances in FOMC communication as great as any that had come
before.
Monetary policy since the onset of the financial crisis
The situation in 2008 and 2009 was like nothing the Federal Reserve had faced since the
1930s. In late 2008, the FOMC cut the federal funds rate nearly to zero - essentially, as low
as it could go - where it has remained. With its traditional tool for expansionary monetary
policy - lowering the federal funds rate - off the table, the FOMC turned to unconventional
and, in some cases, newly invented policy options to try both to help stabilize the financial
system and to arrest the plunge in economic activity. The public had grown accustomed to
monetary policy that focused on changes to the federal funds rate target, with occasional,
and at this point fairly limited, guidance that a particular policy stance would probably last for
a while. Beyond the task of describing the new policies, extensive new communication was
needed to justify these unconventional policy actions and convincingly connect them to the
Federal Reserve's employment and inflation objectives.
The best known of these unconventional policies is large-scale asset purchases, commonly
known as quantitative easing. Starting in late 2008 and continuing through today, the Federal
Reserve has purchased longer-term government agency debt securities, agency-guaranteed
mortgage-backed securities, and longer-term Treasury securities that have added about
$2.5 trillion to its assets. These purchases were intended to, and I believe have, succeeded
in significantly lowering longer-term interest rates and raising asset prices to help further the
Federal Reserve's economic objectives. This is an easing of monetary policy, also known as
accommodation, beyond what is provided by maintaining the federal funds rate close to zero.
It is important to emphasize that the effects of asset purchases also depend on expectations.
If the FOMC buys, say, $10 billion in longer-term securities today but is expected to sell them
tomorrow or very shortly, there will be little effect on the economy. Current research suggests
that the effects of asset purchases today depend on expectations of the total value of
securities the FOMC intends to buy and on expectations of how long the FOMC intends to
hold those securities. To make these asset purchases as effective as possible in adding
accommodation, the FOMC, therefore, needs to communicate the intended path of Federal
Reserve securities holdings years into the future. I will return in a moment to current and
possible future ways in which the FOMC does and might communicate this information.
The other unconventional policy designed to contribute to monetary easing was almost
purely communication - enhanced forward guidance about how long the Committee expects
to maintain the federal funds rate near zero. The situation in early 2009 was similar to 2003
but even more challenging, because in that earlier episode, the FOMC at least retained the
option of a further reduction in the federal funds rate target. In 2009, communication about
the future path of the federal funds rate was the only option.
Initially, the forward guidance was simple and familiar: The FOMC statement noted that
"economic conditions are likely to warrant exceptionally low levels of the federal funds rate
for an extended period."7 The Committee enhanced its forward guidance in August 2011,
when it substituted "at least through mid-2013" for the words "an extended period."8 This date
was moved into the future several times, most recently last September, when it was shifted
to mid-2015.9
This "calendar guidance" was an advance over the indefinite "extended period," but it
suffered from an important limitation. The date failed to provide the public with a clear
understanding of what conditions the FOMC was trying to achieve or the economic
conditions that would warrant a continuation of the policy. As a consequence, it was hard for
the public to tell whether a change in the calendar date reflected a shift in policy or a change
in the Committee's economic forecast.
To help provide greater clarity about the Committee's objectives, in January 2012, the FOMC
adopted and released a statement of its longer-run goals and monetary policy strategy.10 This
statement laid out, for the first time, the rates of inflation and unemployment that the FOMC
considers consistent with the dual mandate. Specifically, it stated that the longer-run inflation
goal most consistent with the FOMC's price stability mandate is 2 percent, and that the
central tendency of FOMC participants' estimates of the longer-run normal rate of
unemployment ranged from 5.2 to 6 percent.
As the statement also made clear, economic developments may cause inflation and
unemployment to temporarily move away from the objectives, and the Committee will use a
balanced approach to return both, over time, to the longer-run goals. On the one hand, for
example, the current rate of unemployment, at 7.7 percent, is far above the 5.2 to 6 percent
range in the statement and is expected to decline only gradually. Inflation, on the other hand,
has been running at or below 2 percent and is expected to remain at similar levels for several
years. In this circumstance, both legs of the dual mandate call for a highly accommodative
monetary policy. With unemployment so far from its longer-run normal level, I believe
progress on reducing unemployment should take center stage for the FOMC, even if
maintaining that progress might result in inflation slightly and temporarily exceeding
2 percent. The Committee reaffirmed this statement in January 2013, and I expect it to
remain a valuable roadmap for many years to come, indicating how monetary policy will
respond to changes in economic conditions.11
Meanwhile, the FOMC has continued to enhance its communication about how it would use
the federal funds rate to return inflation and unemployment to its longer-run objectives. Last
December, the Committee replaced its calendar guidance for the federal funds rate with
quantitative measures of economic conditions that would warrant continuing that rate at its
current very low level. Specifically, the Committee said it anticipates that exceptionally low
levels for the federal funds rate will be appropriate "at least as long as the unemployment
rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to
be no more than a half percentage point above the Committee's 2 percent longer-run goal,
and longer-term inflation expectations continue to be well anchored."12
I consider these thresholds for possible action a major improvement in forward guidance.
They provide much more information than before about the conditions that are likely to
prevail when the FOMC decides to raise the federal funds rate. As for the date at which
tightening of monetary policy is likely to occur, market participants, armed with this new
information about the Committee's "reaction function," can form their own judgment and alter
their expectations on timing as new information accrues over time.
These thresholds will, as a consequence, allow private-sector expectations of the federal
funds rate to fulfill an important "automatic stabilizer" function for the economy. If the
recovery is stronger than expected, the public should anticipate that one or both of the
threshold values will be crossed sooner and, hence, that the federal funds rate could be
raised earlier. Conversely, if the outlook for the economy unexpectedly worsens, the public
should expect a later "liftoff" in rates - an expectation that would reduce longer-term interest
rates and thereby provide more-accommodative financial conditions.
Communication and monetary policy challenges ahead
The threshold guidance for the federal funds rate looks ahead to a time when the economy
has healed from the worst effects of the financial crisis. Getting back to more normal
economic conditions will allow for a more normal approach to monetary policy. I look forward
to the day when we can put away our unconventional tools and return to what now seems
like the relatively straightforward challenge of setting the federal funds rate.
At some point it will be appropriate to cease adding to accommodation and, later, to begin
the process of withdrawing the significant accommodation required by the extraordinary
conditions caused by the financial crisis. I believe that, once again, communication will play a
central role in managing this transition.
Let me start with our current program of asset purchases, which was launched in September
2012 and revised in December. Notably, the FOMC has described this program in terms of a
monthly pace of purchases rather than as a total amount of expected purchases. The
Committee has indicated that it will continue purchases until the outlook for the labor market
has improved substantially in a context of price stability. In its most recent statement, the
FOMC also indicated that the pace and composition of the purchases may be adjusted
based on the likely efficacy and costs of such purchases, as well as the extent of progress
toward the Federal Reserve's economic objectives.13 In my view, adjusting the pace of asset
purchases in response to the evolution of the outlook for the labor market will provide the
public with information regarding the Committee's intentions and should reduce the risk of
misunderstanding and market disruption as the conclusion of the program draws closer.
The Federal Reserve's ongoing asset purchases continually add to the accommodation that
the Federal Reserve is providing to help strengthen the economy. An end to those purchases
means that the FOMC has ceased augmenting that support, not that it is withdrawing
accommodation. When and how to begin actually removing the significant accommodation
provided by the Federal Reserve's large holdings of longer-term securities is a separate
matter. In its March statement, the FOMC reaffirmed its expectation that a highly
accommodative stance of monetary policy will remain appropriate for a considerable time
after the current asset purchase program ends and the economic recovery has
strengthened.14 Accordingly, there will likely be a substantial period after asset purchases
conclude but before the FOMC starts removing accommodation by reducing asset holdings
or raising the federal funds rate.
To guide expectations concerning the process of normalizing the size and composition of the
Federal Reserve's balance sheet, at its June 2011 meeting, the FOMC laid out what it called
"exit principles." In these principles, the FOMC indicated that asset sales would likely follow
liftoff of the federal funds rate. It also noted that, in order to minimize the risk of market
disruption, the pace of asset sales during this process could be adjusted up or down in
response to changes in either the economic outlook or financial conditions. For example,
changes in the pace or timing of asset sales might be warranted by concerns over market
functioning or excessive volatility in bond markets. While normalization of the Federal
Reserve's portfolio is still well in the future, the FOMC is committed to clear communication
about the likely path of the balance sheet.
There will come a time when the FOMC begins the process of returning the federal funds
rate to a more normal level. In their individual projections submitted for the March FOMC
meeting, 13 of the 19 FOMC participants saw the first increase in the target for the federal
funds rate as most likely to occur in 2015, and another expected it to occur in 2016. But the
course of the economy is uncertain, and the Committee added the thresholds for
unemployment and inflation, in part, to help guide the public if economic developments
warrant liftoff sooner or later than expected. As the time of the first increase in the federal
funds rate moves closer, in my view it will be increasingly important for the Committee to
clearly communicate about how the federal funds rate target will be adjusted.
I hope I've been able today to convey the vital role that communication plays in the Federal
Reserve's efforts to promote maximum employment and stable prices. Communication
became even more significant after the onset of the financial crisis when the FOMC turned to
unconventional policy tools that relied heavily on communication. Better times and a
transition away from unconventional policies may make monetary policy less reliant on
communication. But I hope and trust that the days of "never explain, never excuse" are gone
for good, and that the Federal Reserve continues to reap the benefits of clearly explaining its
actions to the public. I believe further improvements in the FOMC's communication are
possible, and I expect they will continue.
It has been my privilege to share these thoughts with you. Thank you for inviting me here
today.