narayana kocherlakota : clarifying the objectives of monetary policy speech by mr narayana kocherlakota, president of the federal reserve bank of minneapolis, at the rapid city economic development / black hills knowledge network forum, rapid city, south dakota, 7 october 2014. * * * thanks to david fettig, terry fitzgerald, rob grunewald and sam schulhofer - wohl for their assistance with these remarks. introduction thank you for that generous introduction, and thank you for the invitation to join you here today. this is my second trip to rapid city since becoming president of the federal reserve bank of minneapolis five years ago, and i ’ m glad to be back. i ’ m planning to spend most of my time today talking about the objectives of monetary policy. as you will hear, the fomc has made great progress in formulating, and communicating, the objectives of monetary policy to the public. i will discuss some of that progress and then move on to some ideas about how the committee can make further improvements along these lines. i look forward to your questions, as well – i always learn a lot from q & a sessions. before i start, though, i must remind you that the views i express today are my own and not necessarily those of my federal reserve colleagues. federal reserve system basics let me begin with some basics about the federal reserve system. i like to tell people that the fed is a uniquely american institution. what do i mean by that? well, relative to its counterparts around the world, the u. s. central bank is highly decentralized. the federal reserve bank of minneapolis is one of 12 regional reserve banks that, along with the board of governors in washington, d. c., make up the federal reserve system. our bank represents the ninth of the 12 federal reserve districts and includes montana, the dakotas, minnesota, northwestern wisconsin and the upper peninsula of michigan. eight times per year, the federal open market committee – the fomc – meets to make monetary policy. all 12 presidents of the regional federal reserve banks – including me – and the governors of the federal reserve board contribute to these deliberations. however, the committee itself consists only of the governors, the president of the federal reserve bank of new york and a rotating group of four other presidents. i ’ m one of those four presidents this year. in this way, the structure of the fomc mirrors the federalist structure of our government

that an aggressive taylor rule is not sufficient to determine inflation. the former authors suggest how price level determination can be achieved using a hybrid rule that augments an activist taylor rule with a commodity price peg. note though that their implementations implicitly require the cb to have the ability to buy back money from the public. if the cb can only hold assets issued by the fa, then the fa ’ s actions will influence the value of the cb ’ s portfolio and thereby influence the cb ’ s ability to implement a given price level path. in this sense, the cb does not have independent control of the price level. bis central bankers ’ speeches should the cb be required to never intervene in this sort of insolvency scenario? i ’ ve argued that a ban on these interventions will give the cb more independence in its control over the price level. for those who think of cb independence as being the foundational element of macroeconomic policy, that pretty much settles the question. but i see a couple of reasons for caution here. it is certainly conceivable that fa insolvency can be triggered by shocks that are well outside the control of the fa itself. and, empirically, fa insolvency is associated with large short - term and even medium - term declines in output. should the cb be prepared to drive the fa into insolvency given the possible adverse economic impact on the country? more subtly, regardless of the fa ’ s solvency, sovereign debt issues can fail simply through a coordination failure among investors. if i, as an investor, don ’ t anticipate that others will buy into the debt issue, i won ’ t either. in this sense, sovereign debt issues may be susceptible to suboptimal “ runs. ” the cb can eliminate this possibility by ensuring the nominal promises of the fa whenever the fa is threatened with default. thus, i see trade - offs. on the one hand, if the cb is known to be willing to intervene to keep the fa solvent, then inflation is necessarily shaped by fiscal considerations and by the shortrun incentives of elected officials. we know from many years of theoretical and empirical research that this effect is not a desirable one. on the other hand, if the cb is fully committed to allow the fa to default if necessary, then even optimal debt management by the fa may end up exposing the country to troubling risks, like sovereign debt runs. let me wrap up. i ’ ve argued that even