On the business and policy fronts, 2012 started with a revelation that Federal Reserve officials would try to enhance clarity and transparency in monetary policy.
One might wonder if this is necessarily a good thing given the Fed’s actual decisions on monetary policy, especially over the past three-plus years. Do we really want to know more about the projections and assumptions that lead to bad policymaking?
While being facetious — well, somewhat facetious — here, the point is that this announcement needs to be put in perspective. After all, any advancements in terms of providing more information as to how Fed Chairman Ben Bernanke and his colleagues make decisions do not outweigh the importance of making better decisions on monetary policy.
What is the Fed doing exactly? The minutes from the Federal Open Market Committee’s Dec. 13 meeting were released on Jan. 3. These revealed that the FOMC would start “incorporating information about participants’ projections of appropriate future monetary policy” into its economic projections, which are released four times each year.
The FOMC is compromised of the Fed’s five governors and the presidents of the 12 regional Reserve Banks, with voting members being the five governors, the New York bank president, and four other regional bank presidents on a rotational basis. The published economic estimates on economic growth, unemployment and inflation are based on each participant’s assessment on where monetary policy is headed. However, up to now, those monetary policy assessments were not published.
Under this new communications policy, starting in late January, the FOMC will present the participants’ views on the appropriate level of short-term interest rates in the near term and over the long run; likely timing of changes in short-term interest rates; and expectations regarding the Federal Reserve’s balance sheet.
Ben Bernanke certainly deserves credit for improving transparency at the Fed. It was not that long ago that Fed officials took pride in their ability to obfuscate. Bernanke, on the other hand, increased the issuance of Fed economic forecasts from twice a year to four times, and started holding press conferences in 2011 after FOMC meetings.
Add in this most recent move to publish expectations on short-term interest rates and the Fed’s balance sheet, and the hope is for more informed decisions and less volatility. Indeed, greater clarity and increased information are good things for markets, reducing guesswork and improving the allocation of resources by investors and businesses.
Unfortunately, none of this gets to the larger matter of actually improving decisions on monetary policy.
It’s critical to understand that monetary policy is the only tool available to establish price stability, i.e., to keep inflation low. Inflation ultimately results when too much money chases too few goods, or to put it another way, when growth in the money supply exceeds money demand. In turn, monetary policy is the wrong tool for trying to boost economic and employment growth.
More so than any limitations on its willingness to more fully communicate, the Fed created tremendous uncertainty when it ran the most expansive monetary policy in our nation’s history from September 2008 to the middle of 2011. The plan was to boost growth and jobs through monetary policy. But while that failed, and even though the Fed has taken a breather in recent months, how this historically loose monetary policy will fully play out in terms of inflation, the value of the dollar and the economy remains a mystery. For good measure, the Fed remains open to further ginning up monetary policy if economic sluggishness persists.
Much of this misguided policymaking goes back to the dual mandate imposed on the Fed by Congress. That is, U.S. monetary policy has two objectives — stable prices and maximum employment. The problem is that many policymakers miss the fact that the best thing that can be done for economic growth and job creation in terms of monetary policy is to maintain price stability, which provides a sound currency, fosters confidence for investment, and keeps interest rates low and stable in the short run and over the long haul.
In terms of more directly affecting the economy and employment, that’s a job for Congress and the White House, namely, by providing tax and regulatory relief, reining in the size of government, and reducing barriers to international trade.
Over the past few years, the U.S. economy has been seriously derailed by a policy agenda that has gotten most of this backwards. Increased government spending, higher taxes and additional regulatory burdens have meant lost output and jobs, and loose monetary policy has created uncertainty in terms of inflation and the dollar.
Offering greater clarity and more transparency when it comes to Fed policymaking is a plus. But investors, businesses and consumers will benefit most when the Fed is properly focused on price stability. To remove doubts and uncertainties, that will require Congress to pass legislation making clear that the Fed’s lone focus should be on price stability, while being able to provide liquidity and serve as lender of last resort in times of crisis.
Ideally, it would be nice if the Fed got policymaking right, and ably communicated that to the world.
Raymond J. Keating is the chief economist for the Small Business & Entrepreneurship Council. His new book is “Chuck” vs. the Business World: Business Tips on TV.