frederic s mishkin : whither federal reserve communications speech by mr frederic s mishkin, member of the board of governors of the us federal reserve system, at the peterson institute for international economics, washington, dc, 28 july 2008. the original speech, with a full list of references, can be found on the us federal reserve system ’ s website ( www. federalreserve. gov ). * * * over the years, the federal reserve has significantly increased the transparency of monetary policy making. for example, starting in 1979, the federal open market committee ( fomc ) has included economic projections of the fomc participants in each semiannual monetary report to congress since 1994, the fomc has publicly announced changes in its target for its policy instrument, the federal funds rate. most recently, the fomc extended the horizon for its projections in october 2007 and is now publishing these projections four times a year. 1 has the federal reserve gone far enough? or would further advances in transparency be useful? i will argue here that the science of monetary policy suggests that the federal reserve can indeed go further in enhancing its communication strategy, and that doing so would produce important benefits in economic performance and democratic accountability. i will also outline a specific proposal of my own and address a few concerns that some might have with elements of this proposal. before proceeding, i would like to emphasize that my remarks today reflect only my own views and not necessarily those of anyone else on the board of governors or the fomc. indeed, this disclaimer has even more meaning now since, as many of you know, i will be leaving the federal reserve board at the end of august and returning to columbia university. 2 what are the key scientific principles for monetary policy communication? to think about what kind of central bank communication is desirable, let's begin by considering some key scientific principles regarding the objectives of monetary policy and the benefits of central bank transparency. objectives of monetary policy the modern science of monetary policy is based on the idea that the central bank's objective is to maximize the economic well - being of the households in the economy ( mishkin 2007d ). broadly speaking, this objective can be expressed in terms of two components : minimizing the deviations of inflation from its optimal rate and minimizing the deviations of real economic activity from its so - called natural rate, which is the efficient level determined by the productive potential of the economy. moreover,

" assessments of the level of maximum sustainable employment, because this level cannot be directly observed and can be inferred only with considerable uncertainty. thus, in making these assessments, monetary policy makers need to draw on a wide range of indicators from labor, product, and financial markets. 9 benefits of central bank communication a central element in successful monetary policy is the establishment of a nominal anchor. why is this so important? the expectations for inflation of households and firms are a key factor in determining the actual behavior of inflation. 10 in the absence of a firm nominal anchor, these expectations may wander as the private sector revises its assessment of the rate at which inflation is likely to settle, and those movements in expectations for future inflation can generate pressure on the current inflation rate. mishkin ( 2007f, 2007g, 2008a, 2008e ) discusses the lender - of - last - resort function and reviews the federal reserve's recent measures for providing additional liquidity to financial markets. mishkin ( 2008c ). mishkin ( 2008b ). this is the point of milton friedman's famous adage, " inflation is always and everywhere a monetary phenomenon " ( friedman, 1963, p. 17 ). mishkin ( 2007b ). mishkin ( 2007c ). mishkin ( 2007a ). by establishing a transparent and credible commitment to a specific numerical inflation objective, monetary policy can provide a firm anchor for long - run inflation expectations, thereby directly contributing to the objective of low and stable inflation. 11 additionally, the presence of a firm nominal anchor gives the central bank greater flexibility to respond decisively to adverse demand shocks. such a commitment helps ensure that an aggressive policy easing is not misinterpreted as signaling a shift in the central bank's inflation objective and thereby minimizes the possibility that inflation expectations could move upward and lead to a rise in actual inflation. a strong nominal anchor can be especially valuable in periods of financial market stress, as we have been experiencing recently, when prompt and decisive policy action may be required to minimize the risk of a severe contraction in economic activity that could exacerbate uncertainty and financial market stress. 12 thus, the establishment of an explicit numerical inflation objective can play an important role in promoting financial stability as well as the stability of employment and inflation. more broadly, it should be noted that central bank transparency contributes importantly to democratic accountability and economic prosperity. 13 in particular, in a democratic society, the