BIG BEN: ON FEDERAL RESERVE COMMUNICATIONS

ABSTRACT

This perspective essay is an attempt to explain what the US Federal Reserve System at Washington D.C. defined as its communications policy under the leadership of Ben Shalom Bernanke who served as the Chairman of its Board of Governors from 2006 to 2014. It also explores briefly the antecedents of the Fed’s communications policy in earlier eras under the chairmanship of Paul Volcker (1979-1987) and Alan Greenspan (1987-2006). The essay also examines the contributions made by Vice Chair Don Kohn, members of the FOMC like Frederic Mishkin and the Federal Reserve System including those of William Poole at the St. Louis Fed to the development and dissemination of the Fed’s communications policy. The essay concludes by comparing the similarities between the communications policy of Ben Bernanke and his successor Janet L. Yellen. The argument in this essay is that there has been an unproblematic continuation in terms of the themes and concerns in the Fed’s communications policy, and that Yellen’s approach as both Vice-Chair and as Chair of the Board of Governors is an attempt to build on the communications policy of her predecessors, and her own work in this area when she chaired the Sub-Committee on Fed Communications under Chairman Bernanke. The main focus is however on Bernanke’s attempt to bring together a number of sporadic attempts in the past to increase the over-all levels of accountability and transparency at the Federal Reserve System in a way that makes his term an interesting case study not only for American bankers but for central bankers everywhere. Bernanke’s term at the Federal Reserve coincided with the emergence of a world-wide movement towards central bank transparency and attempts by central banks to innovate unconventional policy measures to stimulate

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the economy in the wake of the financial crisis of 2008. So, in addition to the usual motifs of accountability and transparency in central banking, Bernanke’s communications policy at the Fed is also characterized by the attempt to explain the rationale for monetary policy tools such as quantitative easing (i.e. large-scale asset purchases) and forward guidance on matters pertaining to the policy path of the short-term federal funds rate. This is an area of Fed policy that Bernanke and increasingly Yellen have made their own.

KEY TERMS: Communications Policy; Federal Funds Rate; FOMC; Forward Guidance; Large-Scale Asset Purchases; Monetary Policy; Quantitative Easing; Unconventional Monetary Policy

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PART ONE

FED-SPEAK: BEN BERNANKE AS GOVERNOR

In remarks made before the American Economic Association, San Diego, California, the then Governor Ben Bernanke of the US Federal Reserve System made the following points on the communication strategy of central banks in general and the Federal Reserve in particular. Since he was not the chairman of the Federal Reserve when these remarks were made on Jan 3, 2004, Bernanke takes responsibility for these remarks as his personal ‘take’ on what a communication strategy should be rather than attribute it to the Federal Reserve or the Federal Open Market Committee (FOMC) in its entirety. It is however important for readers to be acquainted with these remarks on communication and information sharing since they show Bernanke not only rehearsing the positions that he was to take in his remarks on ‘Federal Reserve Communications’ at the Cato Institute on Nov 14, 2007, but explain the main assumptions and evidence that shaped his thought process on the Fed’s emerging communications policy even before he became chairman of the Board of Governors of the Federal Reserve in 2006.1 Bernanke’s point of departure in forging

1 Bernanke, Ben S. (2004). ‘Remarks’ by Governor Ben S. Bernanke at the Meetings of the American Economic Association, San Diego, California, January 3, 2004, available at:

www.federalreserve.gov/boarddocs/speeches/2004/200401032/default/htm

See also Bernanke’s remarks after he became chairman, Bernanke, Ben S. (2007). ‘Federal Reserve Communications,’ 25th Annual Monetary Conference, Cato Institute, Washington D.C., November 14, available at:

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a communications policy for the Federal Reserve was Norman Montague of the Bank of England who was preoccupied with the maxim: ‘never explain, never excuse.’

Those of us who may not be acquainted with central bank communications before the Bernanke era might be surprised by the complete absence of the need for communicating a rationale for monetary policy in the Montague era when central banking was a matter of great secrecy, intrigue, and mystique.2 This approach to central banking was embodied in Federal Reserve policy until quite recently. There was even, for instance, a case titled Merril vs FOMC in 1975 in which the FOMC came up with a number of arguments to justify secrecy as a valid approach to central banking.3 It is however

http://www.federalreserve.gov/newsevents/speech/bernanke/bernanke20071114a.htm2 For a brief introduction to the life of Norman Montague, see ‘A Strange and Lonely Man,’ in Ahamed, Liaquat (2009). Lords of Finance: 1929, The Great Depression and the Bankers Who Broke the World (London: William Heinemann), pp. 23-33. 3 See Goodfriend, Marvin (1985). ‘Monetary Mystique: Secrecy and Central Banking,’ Federal Reserve Bank of Richmond, Working Paper 85-7, where he offers a cost-benefit analysis of secrecy in central banking.

Not only did Goodfriend argue that secrecy can be beneficial in certain circumstances, but situates his arguments in the context of the literature of secrecy in central banking. The pendulum has however now swung the other way, and we are seeing the emergence of a literature that emphasizes the need for transparency, information-sharing, and a formal communication policy under Ben Bernanke at the Federal Reserve. Goodfriend’s paper is available at :

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not really the case that monetary policy was arbitrary since central bankers had some idea of what their strategic rationale was - though for all practical purposes - it came across as arbitrary due to the absence of a formal communication policy. Given that Bernanke himself invokes Montague as an important predecessor, the questions that are worth addressing in this context include the following: Why did central banks change their mind about the need to conduct their business in secret? Why did they decide to communicate the strategic rationale for their policy actions? How did they go about formulating and articulating a communications policy? What readers will also find of interest here is that the Federal Reserve’s preoccupation with communications as a tool for increasing transparency in a democracy is related not only to the political ideal of transparency, but is also enabled by certain macroeconomic assumptions that should be made explicit. 4 What Bernanke does in his remarks is to do precisely that. So it is not that Montague was against transparency per se; the problem was that the macroeconomics of his time was not on a stable footing. We must also remember that Montague lived in a pre-Keynesian era when macroeconomics had not yet been invented in its contemporary form, and the possibility that it could serve as the foundations of monetary policy was not widely understood.5 It was also thought transparency – as opposed to a sense of mystique and secrecy – could

http://www.richmondfed.org/publications/research/working_papers/1985/pdf/wp85-7.pdf4 For a discussion on how the increasing levels of transparency in FOMC deliberations affects the markets, see Poole, William and Rasche, Robert H. (2003). ‘The Impact of Changes in FOMC Disclosure Practices on the Transparency of Monetary Policy: Are the Markets and FOMC Better ‘Synched,’?’ The Federal Reserve Bank of St. Louis Review, January/February, 2003, pp. 1-9.

5 Macroeconomics in its present form became available to economists only after they realized that Keynes’s General Theory was not reducible to depression-era economics, but had structural implications for fiscal policy, monetary policy, and the macro-economy as a whole. It is difficult for those who think in terms of the macro-economy to even envisage what sort of a cognitive space existed in both academia and public policy before Keynes. As the economic historian Peter Clarke points out, ‘few economists would disagree that Keynes played a key role in establishing the importance of macroeconomics.’ Clarke notes that while the term macroeconomics ‘was not used until the 1940s, and never by Keynes himself, the study of the system as a whole surely informs his approach.’ See Clarke, Peter (2009). Keynes: The Twentieth Century’s Most Influential Economist (London: Bloomsbury), p. 150.

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even damage the Fed since ‘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.’ 6

Compare the situation in Montague’s time with the state of economics as recently as 2006 when Edward Prescott could announce openly that macroeconomics had become a ‘science’ because it had finally got its

An important problem in the study of macroeconomic aggregates that would be of consequence is how aggregates are determined by ‘the sum of myriad individual choices,’ and whether these choices are affected by ‘rational expectations,’ or as Robert Skidelsky, the Keynesian scholar, puts it, by ‘conventional expectations.’ If the latter is the case, there is no need to pursue a unified field theory of macroeconomics based on rational expectations; it will suffice if policy makers are acquainted with the conventional expectations that characterize any given area of economic policy making it much easier for them to reduce ‘the amount of uncertainty in the economic system as a whole.’

See Skidelsky, Robert (2009). Keynes: The Return of the Master (London: Penguin Books), pp. 188-189. The differences between the two forms of ‘expectations’ mentioned above will have implications for the Federal Reserve’s communication policy since Ben Bernanke is working within a model of rational expectations and not conventional expectations. For an introduction to why the problem of ‘expectations’ is important not only in the context of macroeconomics, but in the context of the monetary history of the United States, see Moss, David (2007). A Concise Guide to

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methodology in place. 7 So while philosophers of science can continue to debate on whether they agree or disagree with Prescott, his announcement is at least symbolic of the fact that it became possible to consider talking about policy matters without being haunted by the fear that getting it wrong sometimes would lead to a loss of credibility for the Fed.8 I will return to Prescott’s argument again the second part of this essay. Indeed, the rules based-approach to monetary policy is related to the work of economists like Prescott and John Taylor who

Macroeconomics: What Managers, Executives, and Students Need to Know (Boston: Harvard Business School Press). Ben Bernanke is himself a co-author of a textbook on macroeconomics with an extensive discussion on monetary theory and monetary policy; see Abel, Andrew B., Bernanke, Ben S., and Croushore, Dean (2013). Macroeconomics, 7th Edition, (New York: Pearson Education).

6 Yellen, Janet L. (2013). ‘Communication in Monetary Policy,’ Remarks by Janet L. Yellen at the Society of American Business Editors and Writers, 50th Anniversary Conference, Washington D.C., April 4, 2013. Needless to say, Yellen disagrees with this point of view and explains in her remarks that ‘the effects of monetary policy depend critically on the public getting the message about what policy will do months or years in the future,’ available at:

http://www.federalreserve.gov/newsevents/speech/yellen20130404a.htm7 The main thrust of Prescott’s argument is that while macroeconomics used to be preoccupied with ‘constructing a system of equations of the national accounts,’ it is now possible – given the breakthrough in methodology – to conceive of macroeconomics as ‘an investigation of dynamic stochastic model economics.’

See Prescott, Edward C. (2006). ‘Nobel Lecture: The Transformation of Macroeconomic Policy and Research,’ The Journal of Political Economy, April 2006, 114:2, pp. 203-235. Prescott has a separate section titled ‘A Success in Following a Good Monetary Policy Rule’ in this lecture; where he points out that ‘people now recognize much better the importance of having good macroeconomic institutions such as an independent central bank’ (p. 209).

8 See also, for instance, a treatment of the same theme by a Fed Governor: Mishkin, Frederic S. (2007). ‘Will Monetary Policy Become More of a Science?’ Finance and Economics Discussion Series (FEDS), Divisions of Research and Statistics and

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point out that things will go wrong every now and then; it is therefore important to delineate a trajectory for the federal funds rate that will be determined by monetary policy rules in order to address the problem of time-inconsistency in policy matters. 9 This approach to monetary policy should however not be construed as a reductive model which can do away with discretion once and for all since ‘the Federal Reserve and other central banks don’t slavishly follow prescriptions from any rule.’ On the contrary, they have learnt from experience that it is important to ‘retain discretion to deviate from

Monetary Affairs, Federal Reserve Board, Washington D.C., Mishkin argues in this paper that while ‘scientific principles are all well and good…they have to be applied in a practical way to produce good policies. The scientific principles from physics and biology provide important guidance for real-world projects, but it is with the applied fields of engineering and medicine that we build bridges and cure patients. Within economics, it is also important to delineate the use of scientific principles in policymaking, as this type of categorization helps us to understand where progress has been made and where further progress is most needed. I will categorize the applied science of monetary policy as those aspects that involve systematic, or algorithmic, methods such as the development of econometric models. Other, more judgmental aspects of policymaking are what I will call the “art” of policymaking’.

Mishkin’s paper is available at:

http://www.federalreserve.gov/pubs/feds/2007/200744/200744pap.pdf9 Taylor’s work in monetary theory is best-know for the so-called Taylor Rule that central banks might want to consider in determining the federal funds rate or the short-term interest rate. A good definition is available in Hafer, R. W. (2005), ‘The Taylor Rule,’ The Federal Reserve System: An Encyclopedia (Westport and London: Greenwood Press), pp. 369-371. For a non-technical exposition of the relevant variables that constitute the structure of the Taylor rule, see Taylor, John B. (2006). ‘Interview with John Taylor,’ Federal Reserve Bank of Minneapolis, June 26, available at: http://www.minneapolisfed.org/pubs/region/06-6/taylor.cfm

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such prescriptions when responding to severe shocks, unusually strong headwinds, or significant asymmetric risks.’ 10

Taylor’s arguments will be taken up in greater detail in the second part of the essay: suffice it to note at this juncture that the main thrust of his argument is that whether or not macroeconomics is a science, there is a lot more agreement amongst macroeconomists on the core principles than is commonly understood. The applications of macroeconomics in the context of monetary and fiscal policy are an attempt to draw upon these core principles. 11

For an examination of whether or not the Fed followed the Taylor Rule in the period leading up to the crisis in the subprime mortgage markets and the implications of that for Fed policy, and the ongoing debate between ‘rules and discretion’ in monetary policy, see Taylor, John B. (2007) ‘Housing and Monetary Policy,’ NBER Working Paper Series, Working Paper 13682, National Bureau of Economic Research, Cambridge, available at: http://www.nber.org/papers/w13682

Taylor also sets out a general theory of monetary rules in Taylor, John B. (2007). ‘The Explanatory Power of Monetary Rules,’ NBER Working Papers Series, Working Paper 13685, National Bureau of Economic Research, Cambridge, available at:

http://www.nber.org/papers/w13685

Taylor’s important work in this area will be invoked again in the next part of this essay. 10 See Yellen, Janet L. ‘Macroprudential Supervision and Monetary Policy in the Post-Crisis World,’ Business Economics, 46:1, p. 9, National Association for Business Economics, available at:

http://www.federalreserve.gov/newsevents/speech/yellen20101011a.htm

11 See Taylor, John B. (1997). ‘A Core of Practical Macroeconomics,’ AEA Papers and Proceedings, May 1997, 87: 2, pp. 233-235.

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FED COMMUNICATIONS AS A MONETARY POLICY TOOL

The Fed has only one major tool to intervene routinely in the economy: the short term federal funds rate though a number of additional tools have come into the picture in the wake of the recent crisis.12 How will moving this lever affect the whole range of changes that are required to steer the broader economy? Why should talking about this lever have any effects on the economy?

These then are the operational questions that Bernanke wants to make sense of in his remarks. This is the question that interests Janet Yellen as well, and, as she points out, ‘puzzled’ her students as well when she used to teach economics: ‘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 ¼ of a percentage point?’13 The Fed however is only 12 See, for instance, the tools listed in Mishkin, Frederic S. (2008). ‘The Federal Reserve’s Tools for Responding to Financial Disruptions,’ Tuck Global Capital Markets Conference, Tuck School of Business, Dartmouth College, Hanover, New Hampshire, February 15, 2008, available at:

http://www.federalreserve.gov/newsevents/speech/mishkin20080215a.htm

See also Musaccchio, Aldo and Roscini, Dante (2009). ‘Necessity and Invention: Monetary Policy Innovation and the Subprime Crisis,’ Harvard Business School, N9-709-041.13 The answer to this question is that it is not the lever of interest rates per se, but the problem of inflationary expectations that moves the economy. In Yellen’s analysis, ‘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.’ See Yellen, Janet L. (2013).

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interested in this lever insofar as Bernanke knows it can ‘influence more important asset prices and yields’ including ‘stock prices, government and corporate bond yields, mortgage rates,’ by structuring the expectations of economic agents. But in order to ensure a reduction in risk in these markets, and shape expectations effectively, the Fed must remember that expectations on the part of economic agents about the value of the federal funds rate in the future are as important as current rates that have already been announced. The market phenomena mentioned above are affected not only by economic realities but also by ‘inflationary expectations.’14 The main wager in Federal Reserve communications therefore, according to Bernanke, is to help stakeholders ‘develop more accurate expectations of the future course of the funds rate.’ The main goal of the Federal Reserve is not to take the markets by surprise or keep it on tenter-hooks, but to make Fed actions more predictable; this will not only ‘reduce risk premiums in asset markets but also influence shorter-term

‘Communication in Monetary Policy,’ Remarks by Janet L. Yellen at the Society of American Business Editors and Writers, 50th Anniversary Conference, Washington D.C., April 4, 2013, available at:

http://www.federalreserve.gov/newsevents/speech/yellen20130404a.htm14 Bernanke has argued elsewhere that it is important to understand inflation expectations because it is ‘central to inflation dynamics.’ There are three important problems that arise from the attempt to understand inflation dynamics: these are inflation expectations per se along with its causal determination and implications. It is therefore important to situate inflation expectations both in monetary and non-monetary terms including exogenous phenomena like ‘oil price shocks.’ The causal determination of how expectations affect ‘actual inflation’ involves identifying the relevant channels of transmission even if they are only ‘indirect.’ And, finally, the Fed must identify the relevant metrics for measuring not only actual inflation but also the problem of inflation expectations. Bernanke concludes his discussion of this topic by noting that while ‘many measures of expected inflation exist, including expectations taken from surveys of households, forecasts by professional economists, and information extracted from markets for inflation-indexed securities…only very limited information is available on expectations of price-setters themselves, namely businesses.’ The relevant questions then, Bernanke concludes, are to decide whose expectations will prevail in determining inflation dynamics and how the Fed must go about determining the appropriate measures in order to do so. See Bernanke, Ben S. ‘Outstanding Issues in the Analysis of Inflation,’ Federal Reserve Bank of Boston, 53 rd

Annual Economic Conference, Chatham, Massachusetts, June 9, 2008, available at:

http://www.federalreserve.gov/newsevents/speech/bernanke20080609a.htm

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yields.’ The goals of Fed communication however are not reducible to what can be achieved in the short term, but must ensure long-term predictability by yielding a better understanding of the ‘term structure of interest rates,’ or as Bernanke puts it, its policy ‘trajectory.’ 15 At the same time, Bernanke’s Fed has always been aware that good communication is not a ‘substitute’ for good policy, but rather a commitment to articulating policy measures to both the financial community and the broader economy.16 Before proceeding further, however, we must consider the situation before Bernanke became chairman. So while it is true that Bernanke invokes Montague as a predecessor, it must be remembered that he succeeded Alan Greenspan who was the last of the Fed chairmen who belonged to the Montague era. What was Greenspan’s approach to Fed communications? How far has Bernanke taken the Fed from the Greenspan approach? In order to answer these questions, we must

15 Bernanke’s former colleague Mishkin has also argued that there is indeed a link between the science of monetary policy, the problem of rational expectations in macroeconomics, and the strategic rationale for the Fed’s communications policy: ‘I have argued that the Federal Reserve’s enhanced communication strategy will improve the public’s understanding of our objectives and policy strategies and thereby enable households and businesses to make better decisions. In addition, enhanced communication can help anchor the public’s inflation expectations, which promotes both price stability and higher economic growth… the new communication strategy is consistent with what the modern science of monetary policy suggests is needed to achieve good monetary policy outcomes.’ See Mishkin, Frederic S. (2007). ‘The Federal Reserve’s Enhanced Communication Strategy and the Science of Monetary Policy,’ Undergraduate Economics Association, MIT, Cambridge, November 29, 2007, available at:

http://www.federalreserve.gov/newsevents/speech/mishkin20071129a.htm 16 Bernanke’s first vice-chair at the Fed Don Kohn put it well when he argued that ‘good communication is a complement to good policy, not a substitute for it. Ultimately central banks are judged on the outcomes for the economy – how well they meet their objectives. No amount of well-designed communication can counter the effects of consistently deficient analysis or poorly judged policy choices.’ So, for Kohn, ‘the most important criteria for judging the effectiveness of communications and transparency… is whether or not they impede making the best possible policy decisions.’ See Kohn, Donald L. (2008). ‘Recent and Prospective Developments in Monetary Policy Transparency and Communications: A Global Perspective,’ National Association for Business Economics Session, Allied Social Sciences Associations Annual Meeting, New Orleans, Louisiana, January 5, 2008, available at:

http://www.federalreserve.gov?newsevents/speech/kohn20080105a.htm

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briefly take a detour through the work of Ethan Harris.17 In order to situate the Fed’s communication policy in the Bernanke era, it is important to understand what Greenspan understood by communication. What is common to the period from Greenspan to Bernanke or even earlier to that of Volcker is the fact that the Fed’s communications policy becomes increasingly important insofar as the Fed is not only communicating with professional Fed-watchers, but is taking its role as a communicator seriously because it has emerged slowly but steadily as the fourth branch of government. 18

‘QUIET REVOLUTION AT THE FED’

Harris points out that central banks used to be secretive about their policy decisions and protocols of decision making because they were afraid of being subject to political criticism. The metaphor of ‘blowing smoke’ was a way of describing the process of obfuscating the Fed’s relations with outsiders that relates to an inherent fear of public criticism on matters relating to monetary policy. The increase in Federal Reserve transparency, in a sense, is related to the decline in criticism of the Fed’s policy and behavior in formulating and articulating monetary policy. Harris argues that the Federal Reserve first attained much greater political and operational autonomy under Presidents Bill Clinton and George W. Bush: this made it easier for Greenspan and Bernanke to open up the inner workings of the Federal Reserve to the outside world. This is the ‘quiet revolution’ that brought the Federal Reserve to public consciousness in a way that was only 17 See, for instance, the chapter titled ‘Blowing Smoke: The Fed’s Evolving Communication Strategy,’ in Harris, Ethan S. (2008). Ben Bernanke’s Fed: The Federal Reserve after Greenspan (Boston: Harvard Business Press), pp. 51-58.

18 Wessel explains exactly how this happened in Wessel, David (2009/10). In Fed We Trust: Ben Bernanke’s War on the Great Panic (New York: Three Rivers Press).

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reserved for the Supreme Court in Washington D.C. The proof of this willingness to let the Fed do its own thing was not to be partisan in appointing Federal Reserve chairmen. There are an increasing number of precedents for Presidents to let members of another party serve. This was the spirit in which President Barack Obama re-nominated Chairman Ben Bernanke to the Federal Reserve in 2010.19 There is a good reason for this: Mankiw points out that macroeconomists who described themselves as the New Keynesians were willing to serve in Washington D.C. unlike the economists belonging to the neo-classical schools. The New Keynesians cut across the political divide since what was at stake was not the endemic conflict ‘between the political right and the political left.’ What was really at stake was ‘a split between pure scientists and economic engineers.’ 20

GREENSPAN’S ‘CONSTRUCTIVE AMBIGUITY’

19 See also Irwin, Neil (2013). ‘The Battle for the Fed,’ The Alchemists: Inside the Secret World of Central Bankers (London: Headline Business Plus), pp. 169-200.

20 Mankiw argues that ‘it is remarkable that the new Keynesians were, by temperament, more inclined to become macroeconomic engineers than were economists working within the new classical tradition. Among the leaders of the new classical school, none (as far as I know) has ever left academia to take a significant job in public policy. By contrast, the new Keynesian movement, like the earlier generation of Keynesians, was filled with people who would trade a few years in the ivory tower for a stay in the nation’s capital. Examples include Stanley Fischer, Larry Summers, Joseph Stiglitz, Janet Yellen, John Taylor, Richard Clarida, Ben Bernanke, and myself. The first four of these economists came to Washington during the Clinton years - the last four during the Bush years. The division of economists between new classicals and new Keynesians is not, fundamentally between the political right and the political left. To a greater extent, it is a split between pure scientists and economic engineers.’ See Mankiw, Gregory N. (2006). ‘The Macroeconomist as Scientist and Engineer,’ available at: http://www/nber.org/papers/w12349

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The Federal Reserve’s communication policy - before it opened up to the world - was often described as ‘constructive ambiguity.’ This is the approach that is mainly associated with Greenspan and could also be found to be the case in central banks around the world. This policy approach attempted to minimize information flows and communications between central banks and their stakeholders. While central banks were willing to announce their decisions, they did not share the policy rationale that would justify their actions. The ‘monetary policy stance’ had to be inferred by commentators: it was not thought necessary to give a formal account of whatever the Federal Reserve’s ‘monetary policy stance’ might be. Harris invokes a number of analogues of the Federal Reserve’s reluctance to go public with its reasons for doing what it was doing from the history of central banking. He calls attention, for instance, to Governor Norman Montague of the Bank of England who went on record as saying: ‘I do not give reasons. I have instincts.’ Greenspan himself was won’t to justifying decisions based on ‘gut feelings.’ Greenspan’s predecessor Paul Volcker thought it important for a Federal Reserve Chairman to cultivate a sense of ‘mystique’ rather than explain his actions. This however did not stop him from giving any number of speeches when required to do so or in attending to Congressional testimonies with the consummate skills of an actor.21 If questioned by Congressional committees, Federal Reserve Chairmen had to talk in a way that was not short of words, but which would veer into something more technical than a member of the committee could comprehend. A technique that Greenspan particularly favored was to speak in a code that only customary Federal Reserve watchers could decipher. The phrase used for this approach was ‘policy by code word.’ This approach minimized the use, or sometimes completely eliminated the use, of numerical targets ‘on the key policy parameters.’ Greenspan himself looked worried if his interlocutors seemed to understand his policy intentions since he did not really attempt to communicate his intentions unambiguously. The main goal in strategic ambiguity was to save the Federal Reserve from embarrassment if it should fail to achieve the stated goals of its monetary policy stance. It was believed, 21 For an introduction to Volcker’s career at the Fed, see Axilrod, Stephen H. (2011). ‘Paul Volcker and the Victory Over Inflation,’ Inside the Fed: Monetary Policy and its Management: Martin through Greenspan to Bernanke (Cambridge and London: The MIT Press), pp. 89-118. See also, Silber, William L. (2012). Volcker: The Triumph of Persistence (London and New York: Bloomsbury Press).

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as Bernanke himself pointed out, that the Federal Reserve could protect its prestige only through constructive ambiguity.22 Greenspan himself does not explicitly discuss his communications policy at the Fed in his recent memoirs. 23

FED-SPEAK & THE FOMC

Another term for this notion of constructive ambiguity was ‘Fed-Speak.’ The main justification for this approach, according to Greenspan, is that uncertainty about the federal funds rate would lead to a situation where some would believe that the Federal Reserve planned to ‘tighten’ rates and some would believe that the Federal Reserve planned to ‘ease’ rates. This uncertainty, Greenspan believed, would make markets more liquid ‘as traders placed their bets’ for or against;

22 Bernanke points out that ‘traditionally, like other central banks, the Fed was reluctant to explain its policy decisions or otherwise engage with the public, partly based on a belief that this approach decreased the effectiveness of monetary policy. However this lack of openness became increasingly out of step with other institutions in our democratic society; it also reduced the effectiveness of Fed policies by inhibiting public understanding and discussion of policy goals and strategies. This approach began to change in the 1990s when the Federal Reserve began to provide more information about how it saw the economic situation and how it would respond. Increasing the Fed’s transparency, openness, and accountability has been one of my top priorities as Chairman.’ As Bernanke’s remarks demonstrate, this is a policy objective that has been the hallmark of his career at the Fed from the time he began as Governor to the time that he presided over the FOMC as chairman. See Bernanke, Ben S. (2013). ‘Teaching and Learning about the Federal Reserve,’ Remarks by Ben S. Bernanke, Chairman, Board of Governors of the Federal Reserve System, Washington D.C., at A Teacher Town Hall Meeting: 100 Years of the Federal Reserve, Nov 13, 2013, available at:

www.federalreserve.gov/newsevents/speech/bernanke20131113a.pdf23 Greenspan, Alan (2007). The Age of Turbulence: Adventures in a New World (New York and London: Allen Lane).

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it ‘would create a desired buffer of both bids and offers.’ Harris argues that given his political connections, it was necessary for Greenspan to equivocate as a way of protecting himself and the Federal Reserve at least in the short term. This approach made it possible for him to play for time and let stakeholders conclude whatever they wanted to. Needless to say, this led to a situation where many Federal Reserve watchers simply got, in Harris’ formulation, just ‘Fed-up.’ When and how did the transition to a greater sense of transparency happen in the Greenspan era? The place to look at - if we want a better understanding of this issue - is not what Greenspan was saying to stakeholders, but in what the Federal Reserve was putting out in terms of formal documentation. What were really at stake were the meetings of the Federal Open Market Committee (FOMC). Starting in 1993-94, the Federal Reserve began to release the transcripts of FOMC meetings along with the policy directives arrived at in these meetings. These transcripts went a long way in defeating conspiracy theorists that expected to find any number of ‘secrets in the temple’ but were disappointed to find that it did not have any. 24 It is these changes in the Greenspan era that set the stage for the whole-scale changes that we now take for granted in Bernanke’s Fed. 25

ON ‘FORWARD GUIDANCE’

Harris points out that Bernanke belongs to a generation that wants to open up the Federal Reserve much more fundamentally to public scrutiny. This means that he has gone beyond incremental changes. It was not only FOMC minutes and policy directives that were released

24 Greider, William (1989). The Secrets of the Temple (New York: Simon & Schuster).25 The minutes or memoranda of FOMC’s meetings have always been of interest to Fed-watchers and market participants. They also became a bit controversial because of legal action that was initiated under the Freedom of Information Act in 1975 in the Merrill case and in the context of the provisions of the Government in the Sunshine Act of 1976. For a discussion on these matters and the opening up of Fed communications in the Greenspan era, see Axilrod, Stephen H. (2011). ‘The Greenspan Years, From Stability to Crisis,’ Inside the Fed: Monetary Policy and its Management, Martin through Greenspan to Bernanke (Cambridge and London: The MIT Press), pp. 119-148. For a more detailed look at the transitional challenges from the Greenspan years to the Bernanke era in the history of the Federal Reserve and its implication for central banking as a whole, see Overtveldt, Johan Van (2009). Bernanke’s Test: Ben Bernanke, Alan Greenspan, and the Drama of the Central Banker (Chicago: Agate Books).

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when Bernanke took over, but Federal Reserve forecasts as well. Bernanke has also perfected a technique called ‘forward guidance’ that will help stakeholders plan their financial futures with a better understanding of what the Federal Reserve intends to do in the future and not merely understand its policy rationale for past actions. This technique is presently being used to forecast the federal funds rate going forward to as far as 2015-2016 and beyond under the aegis of ‘monetary policy accommodation.’ 26 While the Federal Reserve doesn’t necessarily guarantee that the trajectory of interest rates will be adhered to - no matter what – it at least promises to explain its policy rationale sufficiently in press conferences should it become necessary to deviate from its own forward guidance under the ‘thresholds, not triggers’ doctrine.27 I will return to this doctrine in the last part of this essay. The element of uncertainty that should be factored into interpreting its forward guidance mechanism is also a part of the Fed’s communications with the financial media. Forward guidance then is the most important technique that the Federal 26 These developments are not reducible to the US Fed or a particular policy tool since, as Bernanke points out, that in addition to forward guidance, the Fed has also sought recourse to large-scale asset purchases like other central banks in response to the recent crisis: ‘To provide additional monetary policy accommodation despite the constraint imposed by the effective lower bound on interest rates, the Federal Reserve turned to two alternate tools: enhanced forward guidance regarding the likely path of the federal funds rate and large-scale purchases of longer-term securities for the Federal Reserve’s portfolio. Other major central banks have responded to developments since 2008 in roughly similar ways. For example, the Bank of England and the Bank of Japan have employed detailed guidance and conducted large-scale asset purchases, while the European central bank has moved to reduce the perceived risk of sovereign debt, provided banks with substantial liquidity, and offered quantitative guidance regarding the future path of interest rates’. See Bernanke, Ben S. (2014). ‘The Federal Reserve: Looking Back, Looking Forward,’ Remarks by Ben S. Bernanke, Chairman, Board of Governors, Federal Reserve System, Washington D.C., at the Annual meeting of the American Economic Association, Philadelphia, Pennsylvania, January 3, 2014, available at:

www.federalreserve.gov/newsevents/speech/bernanke20140103a.pdf27 For a discussion of the ‘thresholds, not triggers’ doctrine, see Bernanke, Ben S. (2014). ‘The Federal Reserve: Looking Back, Looking Forward,’ Remarks by Ben S. Bernanke, Chairman, Board of Governors, Federal Reserve System, at the Annual Meeting of the American Economic Association, Philadelphia, Pennsylvania, January 3, 2014, available at:

www.federalreserve.gov/newsevents/speech/bernanke20140103a.pdf

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Reserve uses to ‘shape expectations going forward.’ The reason that this technique has found so much favor with the Federal Reserve stems from the fact that Bernanke was trained in the ‘rational expectations equilibrium’ approach to doing economics.28 But this trend is not reducible to Bernanke’s approach to central banking: it has been around for a while in the Federal Reserve System.29 These are trends in central banking that began with his predecessors Volcker and Greenspan.30 Not all Fed-watchers are however in favor of this approach to Fed communications since market participants can get used to forward guidance and will not be able to apply their minds effectively should the Fed decide not to continue with such an accommodative approach to monetary policy in the future.31 There has 28 For a history of the term ‘rational expectations’ in macroeconomics, see Kantor, Brian (1979). ‘Rational Expectations and Economic Thought,’ Journal of Economic Literature, 17, pp. 1422-1441. See also Hafer, R. W. (2005). ‘Rational Expectations,’ The Federal Reserve System: An Encyclopedia (Westport and London: Greenwood Publishers), pp. 319-321.29 See, for instance, Poole, William (2000). ‘Expectations,’ Twenty-Second Henry Thornton Lecture, Department of Banking and Finance, City University, London, November 28, 2000. Poole points out that the ‘rational expectations revolution in macroeconomics changed forever how we think about economic policy. We know that understanding markets requires that we understand market expectations about monetary policy. We know that the distinction between policy actions and policy itself is of central importance. We know that expectations are not always fully rational, but I have been at pains to argue that some of the problems caused by nonrational expectations are correctable.’ This lecture is available at:

http://www.stls.frb.org/news/speeches/2000/11_28_00.html30 In his recent remarks, Bernanke says that ‘I would be remiss if I did not point out, especially with Paul [Volcker] and Alan [Greenspan] here, that the Fed’s recent communications innovations owe a great deal to developments like the monetary targeting framework devised under Chairman Volcker and the post-Federal Open Market Committee statement and qualitative forward guidance introduced under Chairman Greenspan.’ See Bernanke, Ben S. (2013). ‘Remarks’ by Ben S. Bernanke, Chairman, Board of Governors of the Federal Reserve System at the Ceremony Commemorating Centennial of the Federal Reserve Act, Washington D.C., Dec 16, 2013, available at:

www.federalreserve.gov/newsevents/speech/bernanke20131216a.pdf 31 See, for instance, Jones, David M. (2014). ‘Contemporary Federal Reserve Policy,’ Understanding Central Banking: The New Era of Activism (Armonk and London: M.E. Sharpe), p. 40.

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also been a sense of concern that the rationale and purpose for forward guidance could be ‘misunderstood.’ Charles Plosser points out that ‘if the public hears that the policy rate will be lower for longer, it may interpret this news as policymakers saying that they expect the economy to be weaker for longer. If that is the interpretation of message, then the forward guidance will not succeed and may even weaken current spending.’ It may also lead to difficulties in communication because it may not always be clear whether forward guidance is meant to be a ‘transparency device’ or a way of saying that the FOMC will be open to more monetary policy accommodation when and if required.32

‘CONSTRAINED DISCRETION’ AT THE FED

The main strategic intent in communicating the anticipated trajectory of the federal funds rate is to ensure that the public at large is not subject to the problem of ‘asymmetric information’ which was the case when the Federal Reserve was reluctant to communicate. In the rational expectations equilibrium model, the markets are more likely to clear, or attain the levels of efficiency that is expected of them only if information asymmetry is minimized - that is the main theoretical rationale in Bernanke’s forays in Federal Reserve communication. This is even more so during a financial crisis.33 It is also worth asking how 32 Plosser, Charles I. (2014). ‘Communication Challenges,’ Speech by Charles I. Plosser, President and Chief Executive Officer, Federal Reserve Bank of Philadelphia, University of Chicago, Booth School of Business, New York City, 28 February 2014, available at:

https://www.bis.org/review/r140303b.pdf33 See, for instance, Mishkin who argues that ‘periods of financial instability are characterized by valuation risk and macroeconomic risk.’ While ‘monetary policy cannot aim at minimizing valuation risk,’ it ‘can reduce macroeconomic risk.’ In order to do this, the Fed will attempt to ease policy. The outcome of such easing will reduce the extent of uncertainty in the markets and make it easier ‘to collect the information that facilitates price discovery, thus hastening the return of normal market functioning.’ Mishkin, Frederic S. (2009). ‘Is Monetary Policy Effective During Financial Crises?’ NBER Working Paper 14678, January 2009, available at:

http://www.nber.org/papers/W14678

See also Bernanke, Ben S. (2013). ‘The Crisis as a Classic Financial Panic,’ Remarks by Ben S. Bernanke, Chairman, Board of Governors, Federal Reserve System at the Fourteenth Jacques Polak Annual Research Conference, Sponsored by the International Monetary Fund, Washington D.C., November 8, 2013, available at:

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the notion of forward guidance is related to the ‘discretion versus policy rules’ debate in monetary policy. Is it a way of avoiding these policy extremes? Most central bankers prefer rules but not to the point that they become helpless during a crisis created by supply shocks (which are beyond their ability to solve). Even the highly celebrated Taylor rule for instance is not meant to be followed literally, but is meant to be understood as a set of policy guidelines or principles. 34 It has been pointed out for instance that ‘an independent central bank is not the same as a rule-bound central bank. The U.S. Federal Reserve has had a high degree of independence without ever committing to a policy rule.’ 35 Forward guidance then becomes a way of making a rule out of a specific instance of discretion: it is quite simply - as Bernanke believes - a specific form of ‘constrained discretion.’ This notion of constrained discretion warrants more discussion since it will interest those who want to take a strategic approach to monetary policy.36

What is at stake here, in my interpretation, is not a misplaced sense of

www.federalreserve.gov/newsevents/speech/bernanke20131108a.pdf34 Taylor argues that real world events like the unification of Germany and the oil-price shocks should caution us against applying monetary policy rules without being sensitive to the historical contexts in which they are being applied. In Taylor’s words, ‘algebraic formulations of such rules cannot and should not be mechanically followed by policymakers.’ See Taylor, John B. (1993). ‘Discretion versus Policy Rules in Practice,’ Carnegie-Rochester Conference Series on Public Policy 39, North Holland, Elsevier Science Publishers B.V., p. 213. For Taylor, ‘a monetary policy rule is defined as a description – expressed algebraically, numerically, graphically – of how the instruments of policy, such as the monetary base or the federal funds rate, change in response to economic variables. Thus a constant growth rate rule for the monetary base is an example of a policy rule, as is a contingency plan for the monetary base. A description of how the federal funds rate is adjusted in response to inflation or real GDP is another example of a policy rule. A policy rule can be normative or descriptive. According to this definition, a policy rule can be the outcome of many different institutional arrangements for monetary policy.’ See Taylor, John B. (1999). ‘A Historical Analysis of Monetary Policy Rules,’ Monetary Policy Rules (Chicago: University of Chicago Press), pp. 319-348, available at: http://www.nber.org/chapters/c7419

35 Mankiw, Gregory N. (2006). ‘The Macroeconomist as Scientist and Engineer,’ available at: http://www.nber.org/papers/w12349

36 See, for instance, Bernanke, Ben S. and Mishkin, Frederic (1992). ‘Central Bank Behavior and the Strategy of Monetary Policy: Observations from Six Industrialized Countries,’ NBER Macroeconomics Annual, 1992, Vol. 7, edited by Blanchard, Olivier Jean and Fischer, Stanley (Cambridge and London: The MIT Press), pp. 183-238.

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idealism or the fact that these are personal choices that are reducible to Bernanke’s personality traits.

What Bernanke seeks is the monetary equivalent of what in jurisprudence is known as ‘the rule of laws, not men.’ 37 The model of rational expectations in economics is based on the methodological need for depersonalization: it doesn’t really matter or at least it should not really matter who is in charge of the Federal Reserve provided that Bernanke’s successors in high office follow the precedents that have been institutionalized by the present and recent members of the FOMC.38 While we don’t hesitate to use the term ‘stare decisis’ in the 37 As Bernanke points out elsewhere, ‘among the Fed’s most important values is the belief that policymaking should be based on dispassionate, objective, and fact-based analysis. The ideal we seek is the combination of the researcher’s intellectual rigor and the ability of the effective policymaker to navigate the messiness of the real world, a world that includes complex institutions and markets, imperfect and incomplete data, and often unpredictable human behavior.’ See Bernanke, Ben S. (2013). ‘Concluding Remarks’ by Ben S. Bernanke, Chairman, Board of Governors of the Federal Reserve System, at the Ceremony Commemorating the Centennial of the Federal Reserve Act, Washington D.C., Dec 16, 2013, at:

www.federalreserve.gov/newsevents/speech/bernanke201312166.pdf38 Whether depersonalization in policy matters is really possible or not – as envisaged by the rational expectations model or by the fundamental assumptions in monetary policy is an open question. See, for instance, Axilrod, a former Secretary to the Federal Open Market Committee and Staff Director at the Fed, who argues that it is possible to situate Fed policy in terms of the institutional history of the Federal Reserve. In order to do this, he believes that it is important to understand how different chairmen have thought about the task ahead of them. It is as important, in other words, to situate the differences between Fed chairmen as what they have in common by virtue of being chairmen. Axilrod, Stephen H. (2011). Inside the Fed: Monetary Policy and Its Management, Martin through Greenspan to Bernanke (Cambridge and London: The MIT Press). See also Jones, David M. (2014). ‘An Evaluation of Contemporary Fed Chairmen,’ Understanding Central Banking: The New Era of Activism (Armonk and London: M. E. Sharpe), pp. 134-156.

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context of the Supreme Court, it is important to remember that what is at stake for the Bernanke Fed is to establish analogously the relevant precedents in monetary policy.39 Bernanke’s legacy, in a larger sense, like that of his predecessors is about the precedents that he and the FOMC have set under his watch: the Federal Reserve is not unlike the Supreme Court in terms of its institutional authority, and Bernanke’s collegial approach is broadly comparable to that of Chief Justice John Roberts.40 But, needless to say, these monetary policy precedents will be affected by reformist measures in the Dodd-Frank Act of 2010 and by any subsequent legislation that directly affects the scope of the Fed’s authority to intervene in the next financial crisis.

‘FORWARD GUIDANCE’ AS PRECEDENT

The most important of these Bernanke precedents is ‘forward guidance’ as a communication technique to not only increase macroeconomic stability, but to stem financial panics in a crisis by invoking a range of socio-economic scenarios within which the Federal Reserve will situate its rationale for deciding on the federal funds rate. Those who don’t situate the Federal Reserve’s communication policy and forward guidance strategies within a model of ‘information symmetry’ (as opposed to the ‘information asymmetry’ model that guided the Greenspan Fed) will simply not understand what Bernanke and his colleagues in the FOMC are up to. What Bernanke is seeking to do is nothing less than to simulate in the minds of relevant stakeholders the protocols of ‘options analyses’ that the Federal Reserve undertakes every time the FOMC meets to decide on the federal funds rate. This will also help to manage inflation expectations, which are as much of a problem for the Federal Reserve as a more tangible notion of core-inflation. Bernanke is also willing to number

39 For Bernanke’s summary of the Fed’s achievements and policy actions during the recent financial crisis, see Bernanke, Ben S. (2013). The Federal Reserve and the Financial Crisis: Lectures by Ben. S. Bernanke (Princeton and Oxford: Princeton University Press).

40 Authoritative introductions to the role played by precedents, i.e. the doctrine of stare decisis in the law can be found in the following texts: Pound, Roscoe (1941). ‘What of Stare Decisis?’ Fordham Law Review, 10:1, pp. 1-13. See also Hardisty, James (1979). ‘Reflections on Stare Decisis,’ Indiana Law Journal, 55:1, pp. 41-69; and Powell Jr., Lewis F. (1990). ‘Stare Decisis and Judicial Restraint,’ Washington and Lee Journal, 47:2, pp. 281-290.

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numbers (which is analogous to the habit of naming names) when it comes to inflation targeting at 2 percent without undue anxiety about whether the Federal Reserve will meet its target. The prestige of the Federal Reserve in Bernanke’s contention is not reducible to making the numbers, but in having the confidence to number the numbers going forward.41 The main goal then of the Federal Reserve’s communication policy is to reduce the endemic forms of socio-economic uncertainty that plagues both monetary policy and regulatory policy. What exacerbate this sense of uncertainty are both information asymmetry and the forms of options analyses that constitute the cognitive style of the members of the FOMC. 42

41 As Bernanke clarified recently, ‘we took another important step in January 2012, when the FOMC issued a statement laying out its longer-run goals and policy strategy. The statement established for the first time, an explicit longer-run goal for inflation of 2 percent, and it pointed out to the SEP to provide information about Committee participants’ assessments of the longer-run normal employment rate, currently between 5.2 and 6 percent.’ The SEP is the summary of economic projections. See Bernanke, Ben S. (2014). ‘The Federal Reserve: Looking Back, Looking Forward,’ Remarks by Ben S. Bernanke, Chairman, Board of Governors, Federal Reserve System, Washington D.C., at the Annual Meeting of the American Economic Association, Philadelphia, Pennsylvania, January 3, 2014, available at:

www.federalreserve.gov/newsevents/speech/bernanke20140103a.pdf42 The Fed has not only to contend with monetary policy but also with the regulation of the banking sector in the United States. It would therefore be incorrect to conclude that the Fed’s communications policy is only an attempt to articulate monetary policy to the exclusion of all other policy, regulatory, and supervisory, and macro-prudential concerns. As Governor Tarullo of the FOMC pointed out recently, the demands of regulatory policy can be as demanding for Fed officials as monetary policy and must overcome similar concerns and constraints: ‘the job of regulating and supervising large, globally active banking organizations is a tough one. Issues of moral hazard, negative externalities, and asymmetric information are, if not pervasive, then at least significant and recurring. The job is only made harder by the fact that these firms cross borders in ways their regulators do not. But we cannot ignore this fact and pretend that we have global oversight.’ See Tarullo, Daniel K. (2014). ‘Regulating Large Foreign Banking Organizations,’ at the Harvard Law School Symposium on Building the Financial System of the Twenty-First Century: An Agenda for Europe and the United States, Armonk, New York, March 27, 2014, available at: www.federalreserve.gov/newsevents/speech/tarullo20140327a.htm

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Bernanke’s theoretical wager in innovating forward guidance as an important tool of monetary policy is to sensitize stakeholders on the need to think like the members of the FOMC. This is a radical departure from the Greenspan approach since it empowers Federal Reserve watchers to think like the Fed and not merely think about the Fed. What Bernanke has done or seeks to do going forward is to dis-intermediate the interpretation of what the Federal Reserve, or more specifically, the FOMC is up to so that economic agents have rational expectations and not irrational expectations going forward. Economic agents are also less likely to project if they learn to think like the Fed rather than think about the Fed. Those who have watched Bernanke addressing press conferences after FOMC meetings will know that one of the responsibilities that he takes up seriously is to sort out economic projections from the underlying economic reality through which the Fed is trying to find its way through the forward guidance mechanism.

CAUSALITY IN MONETARY POLICY

Why then did Bernanke have trouble in communicating with stakeholders, Harris wonders, when he was a rookie at the Federal Reserve? The answer, I think, has less to do with his inherent abilities as a communicator on policy matters and relates more to the expectations of stakeholders who were used to constructive ambiguity as a way of life. After all, constructive ambiguity is not reducible to monetary policy; as any politician can vouch, it is the approach to communication that characterizes fiscal policy as well. And, most importantly, the political process is based on constitutive forms of information asymmetry – so there was simply no expectation that it could or should be any better. It is only those who situate Bernanke’s communication strategy within the ideal of information symmetry, as the constitutive principle of the ‘rational expectations model of

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equilibrium,’ who will appreciate Bernanke’s anxiety about the relationship between ‘cause’ and ‘effect’ in monetary policy (given that much of monetary policy works as a lag variable).43 What is ultimately at stake for Bernanke is the ‘give-and-take’ between monetary theory and monetary policy.44 What are the determining conditions, Bernanke probably asks himself, in the notion of ‘causality’ that will make it possible for monetary theory to pass muster in the more demanding realm of monetary policy given the endemic problem of lag variables?45

This is a question that Bernanke and other central bankers have tried to answer in ways that are in conformity to their own theoretical approaches to monetary policy given their institutional anxiety about what policy options are available whenever the federal funds rate reaches zero as is the case now. In fact, as we will see in the last part 43 The term ‘information asymmetry’ has become increasingly important in monetary policy. The term became well-known in an area of research known as the ‘economics of information,’ but is being increasingly used by monetary economists to explore a range of phenomena to explain how financial crises occur and how information asymmetry can exacerbate these crises. See, for instance, Hafer, R. W. (2005). ‘Asymmetric Information,’ The Federal Reserve System: An Encyclopedia (Westport and London: Greenwood Press), pp. 10-11. For a detailed analysis of the different models of causation in economic history and the differences between monetary and non-monetary explanations of financial crises, see Mishkin, Frederic S. (1990). ‘Asymmetric Information and Financial Crises: A Historical Perspective,’ NBER Working Papers Series 3400, July 1990, National Bureau of Economic Research. The term ‘asymmetric effects’ as opposed to ‘information asymmetry’ is also used in monetary policy and has a different meaning: it is important not to conflate the differences between these terms. Asymmetric effects relates to the differences in how causal relationships can be observed when monetary policy is ‘tightened’ as opposed to when it is ‘eased.’ It is an attempt to answer the following question: ‘Does tight monetary policy slow the economy more than easy monetary policy accelerates the economy?’ Morgan not only formulates this question well, but attempts to answer it in the affirmative. See Morgan, Donald P. (1993). ‘Asymmetric Effects of Monetary Policy,’ Economic Review, Federal Reserve Bank of Kansas, Second Quarter 1993, p.21, also available at:

https://www.kc.frb.org/PUBLICAT/ECONREV/econrevarchive/1993/2q93MORG.pdf44 See Bernanke, Ben S. (2005). ‘The Transition From Academic to Policy Maker,’ Remarks by Governor Ben S. Bernanke at the Annual Meeting of the American Economic Association, Philadelphia, Pennsylvania, January 7, 2005, available at:

http://www.federalreserve.gov.boarddocs/speeches/2005/20050107/45 See Hafer, R. W. (2005). ‘Lags in Monetary Policy,’ The Federal Reserve System: An Encyclopedia (Westport and London: Greenwood Press), pp, 217-218.

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of this essay, explaining the additional tools of monetary policy under the aegis of forward guidance and large-scale asset purchases constitute the main goals of Fed communications in the wake of the financial crisis of 2008.46

INFORMATION SYMMETRY & ASYMMETRY

What are the conditions in which participants will benefit from Federal Reserve communications? What will such a world look like? How will the Federal Reserve clarify its strategic objectives to itself and to participants in such a world? The most important attribute of such a world, according to Bernanke, is that it is a world characterized by ‘information symmetry.’ Bernanke defines this term to mean that central banks and firms will have access to similar amounts of information. There are three important preconditions that must be met to facilitate the convergence of ‘rational expectations equilibrium’ in such a world; those preconditions are the following: ‘systematic policymaking, financial-market efficiency, and symmetric information.’ What going public with its rationale for the federal funds rate forces the Federal Reserve to do is to make sure that it understands not only its own strategic rationale, but the need to proceed systematically within a specified trajectory for setting interest rates, and increase its levels of transparency in the attempt to increase its over-all levels of efficiency? But if there is too much information asymmetry between the Federal Reserve and market participants then it will lead to a mispricing of ‘bonds and other assets.’ While the consequences of information asymmetry in the stock exchanges is well-known, there

46 Bernanke argues that ‘our continuing challenge is to make financial crises far less likely and, if they happen, far less costly. The task is complicated by the reality that every financial panic has its own unique features that depend on a particular historical context and the details of the institutional setting…In 1907, no one had ever heard of an asset-backed security, and a single private individual could command the resources needed to bail out the banking system; and yet, fundamentally, the Panic of 1907 and the Panic of 2008 were instances of the same phenomenon…The challenge for policy makers is to identify and isolate the common factors of crises, thereby allowing us to prevent crises when possible and to respond effectively when not.’ See Bernanke, Ben S. (2013). ‘The Crisis as a Classic Financial Panic,’ Remarks by Ben S. Bernanke at the Fourteenth Jacques Polak Annual Research Conference, Sponsored by the International Monetary Fund, Washington D.C., November 8, 2013, available at:

www.federalreserve.gov/newsevents/speech/bernanke20131108a.pdf

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are analogous phenomena in the markets that central banks may overlook since markets are thought to be much more diffuse than stock exchanges (that are concentrated in a way that makes it easier to think about the modalities of price discovery). In addition to these market-based phenomena, Bernanke argues that information asymmetry will affect the ‘economic welfare’ of a society.

ADAPTIVE LEARNING & MONETARY POLICY

The argument in support of this contention is related to the relationship between ‘adaptive learning and monetary policy,’ where inaccurate expectations and the process of learning through the process of participation in the financial markets, will affect policy outcomes negatively, or make it much more difficult to attain the desired equilibrium in the rational expectations approach to the macro-economy. These are the sort of socio-economic mechanisms that can be uncovered in situations like stagflation, declines in output, and increase in levels of inflation. It is important to educate the public about how ‘erroneous expectations’ can negatively affect economic outcomes. The most important case-example in this context of a sub-optimal macroeconomic outcome is the quagmire of stagflation that devastated the US economy in the 1970s. There is no mechanical way of moving the levers of monetary policy in such instances since economic behavior is necessarily mediated by inflationary expectations in the economy. These inflationary expectations, needless to say, are exacerbated in situations characterized by information asymmetry making policy interventions ineffective. Of course, there is another assumption here that is not sufficiently explored in this context. Will all the available information be factored into the behavior of economic agents so that their expectations will be moderated rather than exacerbated by the availability of information? Why furthermore should economic agents believe the authorities or their interpretation of the information? While the answer to these questions will vary depending on how much credibility has been established between a central bank and its stakeholders, it is nonetheless the case that while information symmetry will not guarantee a rational expectations equilibrium, information asymmetry will guarantee or at least increase the probability of sub-optimal outcomes in the macro-economy. So we can infer that while Federal Reserve communications will not always moderate inflation expectations, the absence of effective Federal Reserve communications might very well increase levels of speculation

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amongst market participants,47 and thereby render it difficult for monetary policy to deliver the desired macro-economic outcomes. In such a scenario, it will be difficult to quickly stabilize the economy during a financial crisis. 48

RULES VERSUS DISCRETION

How should we evaluate the success, if any, of this embryonic version of the Federal Reserve’s communication policy? Bernanke points out that one important criteria of success constitutes the ability of market participants to predict Fed policy - at least in the short term. In his assessment, market participants should have learnt to predict Federal Reserve policy by being attentive to its attempts at providing forward guidance on the federal funds rate. While this form of ‘adaptive learning’ amongst market participants is necessary, it is not sufficient. What is really required is their ability to determine what the Federal Reserve’s long-term goals, its ‘inflationary objectives,’ are in the long term as well. The inability to do this effectively will, as pointed out 47 Shiller, Robert J. (2005). ‘Speculative Volatility in a Free Society,’ Irrational Exuberance (New York and London: Currency Doubleday), pp. 207-230.

48 Shiller argues that important changes may well be underway in central banking and that we cannot be sure that central banks will persist in their contemporary form in the future.

It is even possible that while we consider the range of monetary policy tools that were innovated to deal with the financial crisis of 2008 with a sense of awe and astonishment, ‘the real story of central banks is not their current array of tools and procedures but their lasting commitment to real-world application of sophisticated financial tools for this purpose.’ The purpose that Shiller invokes is, needless to say, the stabilization of the economy during financial crises through monetary and fiscal policies. See Shiller, Robert J. (2012). ‘Policy Makers in Charge of Stabilizing the Economy,’ Finance and the Good Society (Princeton and Oxford: Princeton University Press), pp. 111-118.

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earlier, have implications for the ‘mispricing of assets’ or in planning ‘long-term agreements’ amongst market participants. Bernanke points out those studies on inflation expectations show that the numerical range of these expectations is 2-3% in the US markets. Most central banks have started to use a similar range to determine the extent of inflation expectations in their respective economies, but as the Fed pointed out recently in the context of its emerging doctrine, these are ‘thresholds, not triggers.’49 What are the lessons here for central banks? What can they do in terms of both formulating and articulating their policy objectives in the broader economy? Will not the goal of policy convergence between the Federal Reserve and market participants imply the availability of a monetary policy rule that can take the guess-work (no matter how educated) out of the policy making agenda once and for all? Will this not imply that the rules versus discretion debates be ended once and for all in favor of the ideal of rules?50 Yellen has pointed out, for instance, in response to questions such as these that central bank communication and research on communication practices can be a force for stability. This is because central banks have not only useful information, but the forms of knowledge that if made known to the broader economy will help to 49 Bernanke took the trouble to explain recently that ‘in December 2012, the Committee introduced state-contingent guidance, announcing for the first time that no increase in the federal funds rate target should be anticipated so long as unemployment remained above 6-1/2 percent, inflation between one and two years ahead was projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continued to be well-anchored. My colleagues and I emphasized that the conditions stated in that guidance were thresholds, not triggers. That is, crossing one of the thresholds would not automatically give rise to an increase in the federal funds rate target; instead, it would signal only that it would be appropriate for the Committee to begin considering, based on a wider range of indicators, whether and when an increase in the target might be warranted.’ The threshold, not triggers doctrine is to be found in this series of remarks by Bernanke. See Bernanke, Ben S. (2014). “The Federal Reserve: Looking Back, Looking Forward,” Remarks by Ben S. Bernanke, Chairman, Board of Governors, Federal Reserve System, Washington D.C., at the Annual Meeting of the American Economic Association, Philadelphia, Pennsylvania, January 3, 2014, available at:

www.federalreserve.gov/newsevents/speech/bernanke20140103a.pdf50 For a description of what is at stake in the ‘rules versus discretion’ problem, see Hafer, R. W. (2005). ‘Rules versus Discretion,’ The Federal Reserve System: An Encyclopedia (Westport and London: Greenwood Press), pp. 342-345.

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align ‘private and central bank expectations about policy and the economy.’ The proof of this for Yellen is the fact that ‘financial markets have become much better at forecasting the future path of monetary policy than they were up to in the late 1980’s, and are more certain of their forecast ex ante, as implied by measured volatilities from options contracts.’ 51

MONETARY THEORY VERSUS MONETARY POLICY

Bernanke cautions his reader at this point since, in actual practice, the Federal Reserve cannot rule out a whole range of contingent factors that will affect the performance of its policy formulation in an uncertain world. So the working compromise seems to be the following: follow a rules-based approach when it is business as usual and a discretionary approach if there is a crisis that requires unconventional forms of intervention.

Milton Friedman’s hope that the monetary base will be allowed to expand at a slow and steady pace year after year – on autopilot – is resisted even by monetarists when they are appointed to the FOMC.52

51 In addition to these factors, Yellen believes that ‘greater transparency has also enhanced Fed accountability, a vital consideration for a government institution in a democracy’. See Yellen, Janet L. (2006). ‘Enhancing Fed Credibility,’ Luncheon Keynote Speech to the Annual Washington Policy Conference, March 13, 2006, available at:

http://aida.econ.yale.edu/~nordhaus/Econ154_Fall_2008/yellen_inflation.pdf52 On this point, Barro notes that ‘Milton has been very successful with the broad proposition that monetary policy activism tends to be mistaken. However, his well-

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The recent financial crisis has seen nothing less than a doubling of the monetary base within three months of the problems of September 2008.53 This is the point at which monetary theory diverges from monetary policy with the exception perhaps of a moderate interpretation of the Taylor rule.54 The main goal of Federal Reserve communication then is not in providing a rule that can be applied by market participants as though it were an algorithm that can determine the federal funds rate on its own, but focuses instead on closing the gap between what the Fed knows and what market participants know known, specific proposal – that a monetary aggregate such as M1 or M2 grow at a pre-specified rate such as 2 or 3 percent per year – has problems. In fact, this area is the only one I know of where Milton pretty much reversed his previous position. The problem is that the real demand for money is not that stable, most dramatically in the current, high-tech financial environment, but also over the longer history. Therefore, a constant growth rate for any monetary aggregate does not ensure anything close to inflation stability. One way or another, a monetary policy aimed at inflation stability has to allow the nominal quantity of money to adjust to shifts in real quantity of money demanded.’

See Barro, Robert J. (2007). ‘Milton Friedman: Perspectives, Particularly on Monetary Policy,’ Cato Journal, 27:2, Spring/Summer, p. 130 53 The concerns raised by traditionalists on this score are discussed in Gavin, William T. (2009). ‘More Money: Understanding Recent Changes in the Monetary Base,’ Federal Reserve Bank of St. Louis Review, March/April 2009, pp. 49-59. The main concern, needless to say, is that of the Fed’s exit strategy though inflation may not be an immediate danger. As Gavin points out, ‘when the time comes to shrink the monetary base, the Fed could allow the lending programs to expire as loans mature and sell the assets that it holds outright...the assets should be priced in the market and the Fed should expect to recover most of its investment in such assets.’ A lucid introduction to the problem of the monetary base and its implications for ‘monetarism’ is available in Hafer, R. W. (2005). ‘Monetarism/Monetarist’ and ‘Monetary Base’ in The Federal Reserve System: An Encyclopedia (Westport and London: Greenwood Press), pp. 246-251.54 See, for instance, the history of the relationship between monetary theory and monetary policy in Goodfriend, Marvin (2005). ‘The Monetary Policy Debate Since October 1979: Lessons for Theory and Practice,’ Federal Reserve Bank of St. Louis Review, March/April, Part 2, pp. 243-262, available at: http://research.stlouisfed.org/publications/review/05/03/part2/Goodfriend.pdf

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in order to ensure that participants behave rationally. This is however easier said than done. It reminds me of Freud’s dictum that a neurosis is not easy to cure by sharing information with a patient about the Oedipus complex since there is a difference between what the analyst knows and what the patient knows. Nonetheless, the clinical wager is that the information generated in the analytic exchange is not without a point. The patient can however meet the rational expectations of the doctor only at the point at which he ‘works-through’ emotionally those chunks of information that have the greatest amount of significance for his neurosis.

WORKING-THROUGH FED POLICY

Likewise, we might want to add to Bernanke’s remarks, the fact that the Federal Reserve chairman, like an psychoanalyst, must exhibit enormous patience while market participants ‘work-through’ the forms of forward guidance, and their own inflationary expectations (which correspond in this analogy to the fantasies that hold the patient in its grip).55 Speculative market phenomena bear an uncanny resemblance to the fantasy structure of a neurosis (including, most commonly, forms of ‘herd-behavior’ during financial panics).56 So while the Federal Reserve may do its bit in sharing a wide-range of documents generated for the deliberations of the FOMC, it remains to be seen whether market participants will work-through the relevant ‘economic forecasts’, ‘economic risks,’ and the models of analysis that are relevant to make sense of the incoming data. And, again, as Bernanke points out, ‘an interest rate forecast is not the same as a policy commitment.’ The danger as always is in the behavior of market 55 Laplanche and Pontalis define working-through as ‘the process by means of which analysis implants an interpretation and overcomes the resistances to which it has given rise. Working-through is taken to be a sort of psychical work which allows the subject to accept certain repressed elements and to free himself from the grip of mechanisms of repetition…From the technical point of view, by the same token, working-through is expedited by interpretations from the analyst which consist chiefly in showing how the meanings in question may be recognized in different contexts.’ See Laplanche, Jean and Pontalis, Jean-Bertrand (1967, 1988). ‘Working-Through,’ The Language of Psycho-analysis, translated by Nicholson-Smith, Donald (London: Karnac Books), pp. 488-489.

56 For an introduction to herd-behavior, see Malkiel, Burton G. (2010).’Herding,’ A Random Walk Down Wall Street (New York and London: W.W. Norton & Company), pp. 225-229.

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participants who might want to apply a reductive approach, and cannot differentiate between the structures of the interest rate’s trajectory as such and a particular point in that trajectory. This is the difference that philosophers and psychoanalysts call attention to when they argue that the terms ‘structure’ and ‘structuration’ are not the same.57 The former is the proposed trajectory of interest rates while the latter is the attempt to incorporate within the trajectory any encounter with a contingent object, event, or situation that makes a reductive approach to the ‘term structure of interest rates’ elusive going forward.58 It is this problem that Bernanke captures when he points out that ‘the use of “fan charts” to indicate the range of uncertainty would be helpful in this regard; and indeed, providing more information about the range of uncertainty for all FOMC forecasts would be a useful innovation.’ Another difficulty in taking a reductive approach is that the Federal Reserve makes decisions in committees: a central bank is not a ‘single actor.’ It is therefore important to capture a range of opinions and perspectives on the data that the FOMC wrestles with in its meetings.59

CONVERGING EXPECTATIONS

The Federal Reserve has to help market participants appreciate a diversity of approaches without being too reductive with incoming data. The FOMC’s approach to a diversity of approaches is the key indicator of how it construes the ‘signal-noise ratio’ (as an information theorist might put it). If diversity of opinion in the FOMC is synthesized effectively and used to educate market participants; it will be construed as a positive signal for taking a non-reductive approach to the determination of the federal funds rate; but if it leads to a 57 The difference between the terms ‘structure’ and ‘structuration’ is captured most accurately by the deconstructive phrase, ‘structurality of structure’ that the French philosopher Derrida made his own in a conference on the human sciences at the Johns Hopkins University in 1966. See Derrida, Jacques (1972). ‘Structure, Sign, and Play in the Discourse of the Human Sciences,’ The Structuralist Controversy: The Languages of Criticism and the Sciences of Man, edited by Richard Macksey and Eugenio Donato (Baltimore and London: The Johns Hopkins University Press), p. 247.58 See, for instance, Hafer, R.W. (2005). ‘The Term Structure of Interest Rates,’ The Federal Reserve System: An Encyclopedia (Westport and London), pp. 372-374.59 A good introduction to the Fed’s propensity to make decisions in committees is Blinder, Alan (2006). ‘Monetary Policy by Committee: Why and How?’ DNB Working Paper No. 92, February 2006, De Nederlandsche Bank.

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cacophony then that will affect the quality of the final decision. What is at stake then in FOMC deliberations is to differentiate between the preliminary discussions and the final decision without falling prey to a reductive model of communication. In order to do this, Federal Reserve communication must provide information that is not only highly segmented but explain how it will affect expectations of Fed-watchers on matters pertaining to policy guidance.60 As information theorists teach us, un-segmented information will come across as noise rather than as a signal on where the Federal Reserve wants to lead market participants in the future.61 It is the convergence of expectations then between the FOMC and market participants (in matters pertaining to anchoring inflation expectations and the trajectory of the federal funds rate) that we can identify as the main criterion invoked by Bernanke for evaluating the success of the Federal Reserve’s communication policy. This convergence not only increases the over-all levels of Fed transparency but also enhances, as Bernanke’s successor Janet Yellen puts it, over-all ‘Fed credibility.’62 That is why it is important to

60 This approach is however not without its dangers since, as Axilrod points out, ‘the future is unknowable both to the Fed and to the markets.’ It is therefore important to proceed with caution since ‘much can be lost in terms of the chairman’s and the Fed’s credibility and policy effectiveness, by getting into the mug’s game of exposing policy intentions and wishes in ways that may be misinterpreted and, in the end, as market conditions change, misleading and ultimately damaging.’ Axilrod, Stephen H. (2011). ‘The Greenspan Years, From Stability to Crisis,’ Inside the Fed: Monetary Policy and Its Management, Martin through Greenspan to Bernanke (Cambridge: The MIT Press), p. 148.61 For an introduction to the role played by FOMC minutes, see Jones, David M. (2014). ‘FOMC Deliberations,’ Understanding Central Banking: The New Era of Activism (Armonk: New York and London: England), pp. 25-30.

62 Yellen’s idea of Fed transparency and credibility being related to each other subsumes the notion that there is a convergence of goals between the Fed and the public. As she puts it, ‘when this happens, one often hears the phrase ‘the markets do all the work of monetary policy,’ meaning that market participants correctly anticipate the actions that the Fed will make in response to economic news and shocks. This alignment of the Fed’s actions and the public’s expectations strengthens the monetary policy transmission mechanism and shortens policy lags. In contrast, in the absence of credibility, policymakers and the public may work at cross-purposes, and monetary policy must act to overcome and dislodge expectations that hinder the achievement of our goals.’ See Yellen, Janet L. (2006). ‘Enhancing Fed Credibility,’ Luncheon Keynote Speech to the Annual Washington Policy Conference, March 13, 2006.

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understand that monetary policy is becomingly increasingly a ‘performative art’ and is not as ‘predictive’ a science as we wanted it to be. In order to create and explain the status of a ‘monetary regime,’ we must understand that markets are themselves ‘a function of language,’ and that the ‘communicative imperatives’ of the Federal Reserve and other central banks are a matter of great import. 63

The next part of this essay will consider the communication policy of the Bernanke Fed after Bernanke became Chairman of the Federal Reserve. It will also consider the contributions made by Don Kohn, Frederic Mishkin, and William Poole to the Fed’s communication policy. I will argue that the FOMC was very responsive to Bernanke’s cues on what they should define as an acceptable approach to communication and took the trouble to pass on the message to as many audiences as possible. The third and final part of this essay will consider Bernanke’s remarks on the relationship between monetary policy and Fed communication policy before concluding his term in 2014; and those of the new chairman, Janet Yellen. Bernanke and Yellen have a fairly similar approach to Fed communications since Yellen was the chairman of the subcommittee that helped to formulate a Fed policy when Bernanke was chairman of the board. Understanding their attempts at ‘co-creating’ Fed communications policy will help readers to make sense of not only what is happening at the Fed at the moment, but what they can expect going forward in the near future. The attempts to number the acceptable range for inflation, unemployment, and the federal funds rate in the Fed’s forward guidance are the areas in which Yellen is known to have made important contributions to the Fed’s communications policy.

http://www.frbsf.org/our-district/press/presidents-speeches/yellen-speeches/2006/march/enhancing-fed-credibility/63 For a discussion of these symbolic themes by a renowned anthropologist, see Holmes, Douglas, R. (2014). in the Economy of Words: Communicative Imperatives of Central Banks (Chicago: University of Chicago Press), passim.

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PART TWO

BERNANKE AT THE CATO INSTITUTE

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.

- Ben S. Bernanke 64

In his recent address on the topic of ‘Federal Reserve Communications,’ at the Annual Monetary Conference of the Cato Institute on November 14, 2007, Fed Chairman, Ben S. Bernanke, went out of his way to explain that good communications has become one of the necessary conditions of effective monetary policy. He begins his address by citing from the 1923 Annual Report of the Federal Reserve Board, which argues that ‘the problems of credit administration in the U.S.’ will be easier to handle if ‘the public understands what the function of the Federal Reserve System is, and on what grounds its policies and actions are based.’ While there is no reason whatsoever to

64 Bernanke, Ben S (2007). ‘Federal Reserve Communications,’ 25th Annual Monetary Conference, Cato Institute, Washington D.C., November 14, available at:

http://www.federalreserve.gov/newsevents/speech/bernanke20071114a.htm

See also Bernanke, Ben S. (2004). ‘Central Bank Talk and Monetary Policy,’ at the Japan Society Corporate Luncheon, New York, New York, October 7, 2004, available at:

http://www.federalreserve.gov/Boarddocs/Speeches/2004/200410072/default.htm

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disagree with Bernanke’s contention, it is interesting to note that the Chairman of the Federal Reserve has set out to explain monetary policy with a vigour that has taken many Fed watchers by surprise.65

Explaining monetary policy or policy decisions of course is not necessarily the same as explaining how the Fed works as an independent institution. The increase in the quality and quantity of Fed communications under Chairman Ben Bernanke is based on the new-found maturity that monetary theory has gained as a discourse (whether or not it has, in fact, become a science). The Fed however has always been willing to explain how it functions as an institution even if it has traditionally been secretive about the modalities involved in formulating and recommending policy on interest rates.66 I will argue that Bernanke’s achievement on this score and indeed those of the Vice Chair Don Kohn and other governors who may have taken a cue from him is an exemplary case study on how public servants must communicate with not only immediate stakeholders, but with peripheral stakeholders as well. Bernanke’s team has taken the trouble to not merely acquaint the intelligent layperson with a set of decisions that they may have recommended on the federal funds rate, the discount rate, and term auction facilities, but have also set out to educate the public at large on the implications of their decisions for (what Bernanke and his fellow governors are fond of describing as) the ‘broader economy.’ These attempts must also be seen in the light of other attempts made by the Fed in recent years to promote economic and financial literacy and in helping the educated lay person to get a glimpse of how central bankers think. 67 It is important to remember that communication in central banking is not reducible to information 65 A lucid introduction to Bernanke’s approach to monetary theory, history, and policy is the ‘Interview with Ben S. Bernanke,’ June 2004, Federal Reserve Bank of Minnesota, available at:

http://www.minneapolisfed.org/pubs/region/04_06/bernanke.cf66 See, for instance, The Federal Reserve System: Purposes and Functions by the Board of Governors of the Federal Reserve System, Washington D.C., 1954 and Questions and Answers about the Federal Reserve System, Federal Reserve Bank of Richmond (Memphis: General Books, 2012). For a contemporary introduction to the structure, functions and operations of the Fed, see Poole, William (2007). ‘Understanding the Fed,’ Federal Reserve Bank of St. Louis Review, January/February 2007, pp. 3-13, available at:

http://stlouisfed.org/news/speeches/2006/08_31_06.html

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sharing per se, but must be understood in the context of segmenting information in order to make it usable. What this basically means is that unless stakeholders understand the conceptual code in which central bankers deliberate, think, and express themselves, the information that is shared will be wasted. It is important to work out the code that characterizes the discourse of central banking so that the information makes sense to those who choose to work with it. There is therefore an opportunity here to embark on a full-fledged research programme to understand the modalities of institutional communication in independent central banking. This is the burden of the argument developed by Tognato on what exactly constitutes policy transparency in the context of central banking. This is also why communicative attempts by the Fed to develop economic and financial literacy are important.68 In addition to explaining the broad rudiments 67 See Mishkin, Frederic S. (2008). ‘The Importance of Economic Education and Financial Literacy,’ Third National Summit on Economic and Financial Literacy, Washington, D.C., available at: http://www.federalreserve.gov/newsevents/speech/mishkin20080227a.htm

See Poole, William (2008). ‘Dollars and Sense,’ Financial Planning Association of Missouri and Southern Illinois, St. Louis, Jan 9, 2008, available at:

http://stlouisfed.org/news/speeches/2008/01_09_08.html

See also Poole, William (2008). ‘Thinking like a Central Banker,’ Market News International, New York, Federal Reserve Bank of St.Louis Review, January/ February, 2008, pp. 1-7, available at:

http://stlouisfed.org/news/speeches/2007/09_28_07.htm68 Furthermore, Tognato, in a summation of Lohmann’s arguments on institutional design in the context of central banking, argues that ‘the debate in the institutional design literature concerning secrecy and independence cf transparency and accountability arises from mistaken premises. The question is not whether monetary policy-making should be fully secretive or fully transparent vis -à-vis a single homogenous audience but whether information is segmented in such a way as to satisfy the collection of audiences attached to a central bank (some audiences will need more information while others will be content with less).’ Lohmann’s framework, incidentally, is know as ‘audience cost theory,’ and is particularly of importance in understanding how these different stakeholders will use the segmented information differently. Lohmann’s arguments were developed initially in the context of the Deutsche Bundesbank. Tognato also calls attention to the arguments put forth by Otmar Issing and Bernhard Winkler of the Bundesbank and subsequently of the European Central Bank on what constitutes genuine transparency. The Issing-Winkler argument is an attempt to go beyond the traditional notions of openness and transparency towards working out the modalities necessary

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and intricacies of monetary policy, the Fed is also interested in increasing the general level of awareness of the monetary policy tools that it has used traditionally and those which it had to conjure up in the wake of the recent financial crisis.69

RHETORIC OF MODERATION

The thrust of my essay will be to examine not only the arguments that Bernanke and his associates have made in public remarks and testimonies before Congress, but to focus on the actual rhetorical form in which they have chosen to articulate their position. This part of essay then will take the form of an interpretation of Bernanke’s address at the Cato Institute along with an examination of the remarks made by Vice Chairman Donald L. Kohn on January 5, 2008 at the National Association for Business Economics Session in its annual meeting at New Orleans, Louisiana. I will also make references to comments made on the challenges and difficulties on the topic of Federal Reserve communications in the formal remarks made by William Poole and other governors of the Federal Open Market Committee (FOMC) from time to time in recent years and by academic scholars working in this area in order to develop a comprehensive to make it possible for the lay-person to develop a genuine understanding of developments in monetary policy, a knowledge that is more likely to be available to the elite in most central bank jurisdictions. The different things that should be done to make this possible are spelt out in Tognato’s paper in considerable detail. This is a project in which central banks can learn from each other irrespective of which jurisdiction they belong to. It is also interestingly one which will allow considerable academic interface since amongst the requirements of such a programme is ‘designing the academic curricula that will produce professional profiles apt to meet’ the demands of central bank communication. See Tognato, Carlo (2005). ‘Is Institutional Efficiency in Independent Central Banking a Communicative Matter?’ Borradores de Economia, No. 263, Banco de la Repűblica, Colombia, available at:

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1021345 69 The traditional tools of monetary policy include changing reserve requirements and the discount rate. The Fed also determines the level of money supply by participating in open market operations that constitute the buying and selling of treasury bonds through the offices of the Federal Reserve Bank of New York. For an account of the traditional tools of monetary policy and the ‘supplementary credit facilities’ that were introduced recently by the Fed, see Musacchio, Aldo and Roscini, Dante (2009). ‘Necessity and Invention: Monetary Policy Innovation and the Subprime Crisis,’ HBS Case N9-709-041, January 21, 2009, pp. 3-4.

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notion of Federal Reserve communications.70 One of the problems that I am specifically interested in addressing is the role of speech in ‘moderating,’ and not just ‘mediating,’ the articulation of Federal Reserve decisions both from the point of view of short-term interest rates and its links to the problem of monetary policy, and the evolution of monetary theory in the United States. The underlying anxiety that is at stake is precisely the question of how ‘internal’ or ‘external’ the articulation of monetary policy is to the formulation of monetary policy. In other words, should the communication strategies of the Fed be understood as a set of reporting strategies to clarify the technical complexities that must be navigated by the FOMC in its deliberations? Or should it be seen as embodying a unique rhetoric of moderation to help the stakeholders come to terms with the broader implications of the key recommendations? Or, is it a combination of both? The former case can be referred to as a ‘technical’ problem and the latter as a ‘semiotic’ challenge. Furthermore, the actual act of making the remarks and testimonies poses the need to generate a poetics for monetary policy that is adequate to the occasion. The underlying anxiety in Fed communications then emerges from the need to engage with the problem of uncertainty in the macroeconomic environment. Reading economic indicators after all is not an exact science and the governors are only human and must worry about the problem of not only inflationary expectations, but managing meaning effectively since bankers are affected by intangibles such as the stigma problem in taking advantage of the discount rate.71 That is probably why Don Kohn 70 See, for instance, the following speeches by President Poole of the St. Louis Fed: Poole, William (2005). ‘How Should the Fed Communicate?’ Center for Economic Policy Studies (CEPS), Princeton University, April 2, 2005, available at:

http://stlouisfed.org/news/speeches/2005/4_02_05.htm

and Poole, William (2005). ‘Communicating the Fed’s Policy Stance,’ at HM Treasury/GES Conference: Is There a New Consensus in Macroeconomics, November 30, 2005, available at:

http://stlouisfed.org/news/speeches/2005/11_30_05.htm71 Bernanke argues that ‘as a tool for easing the strains in money markets, the discount window has two drawbacks. First, banks may be reluctant to use the window, fearing that markets will draw adverse inferences about their financial condition and access to private sources of funding – the so-called stigma problem. Second, to maintain the federal funds rate near its target, the Federal Reserve System’s open market desk must take into account the fact that loans through the

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is at pains to explain that a communications strategy must not only be external to monetary policy but must be seen to be external as well. In Kohn’s words, ‘Good communication is a complement to good policy, not a substitute for it.’ 72 In order to understand this problem of how communications is linked to the formulation and articulation of monetary policy, I will set out the main arguments in recent addresses by the Chairman and Vice-Chairman as a prelude to further analysis.73

Suffice it however to note that the rhetorical dimension of policy

discount window add reserves to the banking system and thus, all else equal, could tend to push the federal funds rate below the target set by the FOMC.’ See Ben S. Bernanke, ‘Financial Markets, the Economic Outlook, and Monetary Policy,’ at the Women in Housing and Finance Exchequer Club Joint Luncheon, Washington D.C., on January 10, 2008, available at:

http://www.federalreserve.gov/newsevents/speech/bernanke20080110a.htm72 Kohn, Donald L. (2008). ‘Recent and Prospective Developments in Monetary Policy Transparency and Communications: A Global Perspective,’ National Association for Business Economics Session, Allied Social Science Associations Annual Meeting, New Orleans, Louisiana, January 5, available at:

http://www.federalreserve.gov/newsevents/speech/kohn20080105a.htm 73 This is of course not a problem that is specific to the Fed but is relevant to recent developments in central banking which demand greater accountability and transparency in central banking. Communications is seen as the essential tool in attaining these objectives. Similar case studies can be written for other central banks as well. The most important of such central banks in terms of the scope of its operations is the European Central Bank (ECB). For an account of the specific challenges of formulating and articulating monetary policy in the Euro zone, see the recent speech by Jean-Claude Trichet, the President of the ECB at Frankfurt on 16 January 2008.

Trichet argues that while the traditional practice was to maintain a veil of secrecy in central banking, the ECB was the first amongst central banks in the industrialised

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articulation becomes urgent whenever there is an attempt at crisis management.

THE GREAT MODERATION

A good example of crisis management, needless to say, is the liquidity crisis following the collapse of the housing market because of defaults in so-called ‘sub-prime’ loans.74 Even major reversals of Fed policy on interest rates after a long hiatus must be articulated carefully in order

world to adopt the policy of making its decisions public as soon as possible. Furthermore, the ECB works on the ‘single voice principle’ to prevent miscommunication or misunderstandings amongst the public and the markets. As Trichet puts it, ‘communication on monetary policy with a single voice is desirable and has been efficiently applied from the start of monetary union.’ The importance of the single voice is also linked to the multi-lingual environment in which the ECB operates: ‘As the ‘porte-parole’ of the ECB and its Governing Council, I think we have shown our capacity to communicate in unison with a high level of team spirit in interaction with a highly sophisticated and complex media network dealing with 320 million European citizens speaking 13 languages.’ See Trichet, Jean-Claude, ‘A Few Remarks on Communication by Central Banks,’ Keynote Address, 25th HORIZONT Award Ceremony, Frankfurt am Maim, 16 January 2008, BIS Review 6/2008, available at: http://www.bis.org/review/v080118b.pdf

While the European Central Bank and the US Federal Reserve are the dominant players in their respective jurisdictions, their structures and functions are by no means the same - for a rigorous compare-and-contrast between these central banks, see Pollard, Patricia S. (2003). ‘A Look Inside Two Central Banks: The European Central Bank and the Federal Reserve,’ The Federal Reserve Bank of St. Louis Review, January/February 2003, pp. 11-30.74 For an account of the role of the Fed in this crisis - especially in the context of lowering interests ‘by more than the Taylor rule prescribed’ and encouraging thereby an increase in demand for housing and the consequent ‘upward spiral’ in housing prices, which, in turn, was not sustainable once the ‘short term interest rate returned to normal levels’ with a rapid fall in demand in housing, see Taylor’s 2007 presentation at the Symposium on Housing, Housing Finance, and Monetary Policy at the Federal Reserve Bank of Kansas City, Jackson Hole, Wyoming. Taylor’s primary concern in this presentation is that the federal funds rate was lower than what it should have been between the years 2003-2006 (given the ‘great moderation of the housing cycle’ in the 1980s). This, in turn, led to ‘the poor credit assessments on subprime mortgages.’ See Taylor, John B. (2007). ‘Housing and Monetary Policy,’ NBER Working Paper Series, Working Paper 13682, National Bureau of Economic Research, Cambridge, available at:

http://www.nber.org/papers/w13682

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to minimize the psychological fall-out in terms of investor or entrepreneurial confidence in the economy. These, then, as the Fed is well aware, are some of the communication challenges that could prove to be an occupational hazard if the psychological and rhetorical dimensions of ‘moderation’ are not attended to. In other words, I am beginning to think that the sense of relief that Bernanke experiences in the notion of “The Great Moderation” in monetary policy following the decline in volatility in the advanced industrial economies in the last two decades has to do with an intuitive understanding of the precariousness that attends to the ‘improved performance of macroeconomic policies, particularly monetary policy.’75 In other words, the sense of relief for the Fed emerges from the fact that the greater the moderation in terms of the macroeconomic environment, the less the variability of both economic ‘output and inflation.’ Hence Bernanke’s insistence that the lessons of the past have been learned well; the Fed can be trusted to remember the crucial takeaways on fighting inflation and in providing an environment that is conducive to economic growth. In other words, the macroeconomist cannot seek the satisfaction of the physicist in formulating a ‘law of nature’ since in the context of monetary policy all the stakeholders will have to be well-behaved to save the theory.

For a lucid introduction to the Taylor rule, see ‘Interview with John Taylor,’ Federal Reserve Bank of Minneapolis, June 2006, available at:

http://www.minneapolisfed.org/pubs/region/06-06/taylor.cfm75 Bernanke, Ben S. (2004). ‘The Great Moderation,’ Remarks by Governor Ben S. Bernanke at the meetings of the Eastern Economic Association, Washington D.C., February 20, available at:

http://www.federalreserve.gov/BOARDDOCS/SPEECHES/2004/20040220/default.htm

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Bernanke is brutally honest at moments like this. After pointing out that ‘The Great Moderation’ is an exciting development given the loss of volatility in the macroeconomic environment and polices, Bernanke is forced to think through what the causes of this phenomenon might be. Amongst the options are ‘structural change,’ ‘improved monetary policy,’ and just plain ‘good-luck.’ While Bernanke would prefer to attribute the moderation to improved monetary policy per se, he is too sophisticated a theorist to do so. His commitment to intellectual honesty and rigour demands that he states at least two important caveats. Firstly, while structural change and good luck are not sufficient enough to explain the moderation, we cannot necessarily infer that whatever remains of the explanatory categories when the others have been eliminated must explain the phenomena of moderation, especially since by Bernanke’s own admission, ‘one might also question whether the change in monetary policy regime was sufficiently sharp to have had the effects I have attributed to it.’ Hence Bernanke restricts the scope of his comments on the causative factors of the socio-economic underpinnings of ‘The Great Moderation’ to that of a provocation rather than a conclusive representation: ‘Moreover, several of the channels by which monetary policy may have affected volatility,’ he argues, ‘remain largely theoretical possibilities and have not received much in the way of rigorous empirical testing.’ In other words, at this point, Bernanke is content to state that his goal was actually ‘to stimulate further research on this question.’ Secondly, to push the implications of this problem further in the absence of empirical analysis will, as Bernanke is only too aware, be a rhetorical move rather than a technical one from within the confines of monetary theory. Bernanke’s genius however lies in being able to forge a poetics where this uncertainty can be staged in his remarks and testimonies without losing the attention span of his readers and listeners.

MONETARY POLICY AT THE EDGE

While Bernanke’s sophistication as a theorist demands that he gives his audiences a repeated glimpse of this moment that skeptical philosophers term ‘aporia’ in the attempt to formulate a robust monetary policy, his hesitation in pushing the argument even further relates to the locus that he occupies as a policymaker rather than as a

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theorist per se. 76 Bernanke’s willingness to suspend the usual set of technical possibilities in invoking monetary policy rules in order to let his audience appreciate the underlying philosophical amplitude in his arguments is an unusual rhetorical skill and helps with audience buy-in. Furthermore, those who have watched Bernanke testimonials on Capitol Hill may recall that as Bernanke has settled into his job, he has learnt not to interrupt members of the committees before whom he has to testify, or respond to their queries in a hurry. Bernanke’s celebrated ability to hold and ‘contain’ the affects generated in Congressional hearings pertaining to crisis-ridden situations is not merely, I think, about the use of communication techniques, but springs from the deeper philosophical base of a professor who has been tested by his ability to handle a whole range of permutations and combinations in graduate seminars and is hardly ever threatened by policy differences or theoretical interventions. There is, furthermore, a Freud-like manner in the Bernanke ‘aura’ that goes way beyond the demands of his job unless there is an implicit ethical compulsion to 76 For an account of ‘The Great Moderation’ from the point of view of an economist rather than that of a policy maker - albeit one who has served as a policy maker, see Taylor, John B. (2007). ‘The Explanatory Power of Monetary Rules,’ NBER Working Paper 13685, available at:

http://www.nber.org/papers/w1368

Taylor’s argument in this lecture is that while exhaustive monetary policy rules may not be available, and that while neither the ‘Taylor Rule’ nor any other set of rules can explain all of macroeconomic phenomena in matters pertaining to the causative socio-economic underpinnings of The Great Moderation, ‘they can explain a great deal.’ And, that furthermore, it is hard to find any research in monetary policy that can work in the absence of some such monetary policy rule or the other. Taylor argues furthermore that the basic difference in monetary policy from the time he was a graduate student in the 1970s to what it is now is precisely in the scope of the applicability of monetary policy rules. While the reigning orthodoxy, as represented in Don Patinkin’s textbook had no room for monetary policy rules at all, the scope of the current set of ambitions in the profession is best embodied in Michael Woolford’s textbook which is ‘nothing but monetary policy rules.’ It is all the more remarkable then that Bernanke is willing to dwell in the possibility of an aporia and proceeds with philosophical caution rather than with a technical notion of what is or is not possible in monetary policy, especially when it comes to invoking the usual repertoire of monetary rules in managing the modalities of intervention. As Taylor points out, ‘the staffs of the Fed and other central banks use policy rules. Even if they do not like to talk about the use of policy rules when they make forecasts and assess trends…It is hard to find a research paper on monetary policy that does not use a monetary policy rule in some form.’ See also Comin, Diego (2009). ‘The Great Moderation,’ HBS Case 9-709-023, Harvard Business School, January 6, 2009, pp. 1-12.

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redefine the possibilities of his role as a policymaker and communicator who understands not only the challenges of inflationary expectations for the formulation of the theory and practice of monetary policy; but, more immediately, the need to manage both meaning and expectations on behalf of the Fed. Bernanke’s remarks then are hardly ever a chore; his abilities as a speaker imbue him with a quiet enjoyment of language. His style is governed by a sense of the theoretical, albeit one with a sense of affective containment. The larger thrust of Bernanke’s communication strategy then is to help us sample his mind not so much in its mastery of technical complexities per se, i.e., in its ability to marshal and deploy a set of monetary policy rules, but in developing a sense of ‘being’ when he nods ever so slightly or holds himself back with stoic dignity at the edge though not at the end of monetary policy while bearing testimony. Truly, they must miss him back home at Princeton.

RHETORIC OF MONETARY POLICY

It is important to unpack Bernanke’s account of what constitutes effective communications by the Fed before looking at supplementary accounts of the Fed’s communication framework by Don Kohn and William Poole in later parts of this essay. I will conclude with an examination of the relationship between monetary policy and its articulation (as a set of actual policy announcements by the Fed) and by examining Bernanke’s final thoughts on Fed communication before he stepped down in 2014. While one can anticipate that there is bound to be a rhetorical element in any communication strategy, we will also have an opportunity to see whether its underlying epistemology has a rhetorical component; and, if so, to what extent. This rhetorical component is generally understood by professional Fed watchers in the context of ‘confidence’ and ‘expectations’ in the performance of the macro-economy and in its relationship with economic fundamentals. The gap that often emerges in the short term between the two is, needless to say, the subject matter of endless commentary about the impact and implications of policy announcements by the Fed.77 The 77 See, for instance, Poole who writes that ‘the Federal Reserve implements policy through open market operations designed to keep the overnight federal funds rate close to the target rate set by the FOMC. Even if the Fed were to implement policy in some other way, there is nothing to guarantee that future policy will be consistent with sustained low inflation. At any given time, success in keeping inflation low requires market expectations that inflation will remain low – the market must have

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discovery or the emergence of a ‘rhetorical’ dimension to policy making and policy articulation by the Fed is not meant to be a critique of the fragility of monetary theory (as though this were a new discovery), but an attempt to work-through the anxiety generated by the interdependence of two variables that complicate the quest for a pure nirvana of technical monetary policy rules: ‘economic confidence’ and ‘inflationary expectations.’ While both these problems are linked to the psychological underpinnings of homo economicus; they are, interestingly, related to the problem of speech, i.e., the actual act of articulating monetary policy by the Chairman and the governors in different public fora and in the various economic ‘projections’ and ‘reports’ that accompany and or serve as the theoretical foundations for such communicative activity (including testimonies before varying committees since the Fed is answerable to Congress). Examples of such communications include the following: the Beige Book, the Blue Book, the Green Book, the post-meeting statement of policy, Minutes of the meetings of the Federal Open Market Committee (FOMC), etc. 78

Furthermore, as Bernanke points out, a subcommittee headed by Vice-Chairman Don Kohn guided the FOMC’s review of the Fed’s communications strategy. The goal of this review was to work out the steps that had to be taken 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.’79

Monetary theorists, I therefore argue, need not lose sleep about the structure of monetary theory per se since their performance and its evaluation is not necessarily dependent on our willingness or their ability to prove that monetary theory is a pure technical exercise in confidence that the central bank will do its job not just today but in the future as well.’ See Poole, William (2000). ‘Confidence and Central Banking,’ The Fain Lecture in Celebration of George Borts’ Fiftieth Year as Professor of Economics at Brown University, Providence, Rhode Island, Oct 14, 2000, available at:

http://stlouisfed.org/news/speeches/2000/10_14_00.html 78 These books are described in Hafer, R. W. (2005). ‘Beige Book,’ ‘Blue Book,’ ‘Green Book,’ The Federal Reserve System: An Encyclopedia (Westport and London: Greenwood Press), pp. 29-30; p.33; and pp. 182-183, respectively.

79 Bernanke, Ben S. (2007). ‘Federal Reserve Communications,’ 25th Annual Monetary Conference, Cato Institute, Washington D.C., November 14, available at:

http://www.federalreserve.gov/newsevents/speech/bernanke20071114a.htm

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developing an inventory of monetary policy rules to the radical exclusion of the rhetorical element.

I do not use the term ‘rhetoric’ in its negative sense of arguing that monetary policy is only rhetoric disguised as a quasi-scientific endeavor, but rather in the sense that sophisticated theorists like Bernanke have always been aware that the role of the Chairman, unlike the technical Fed insider, is to straddle and, if necessary, help the community of Fed watchers to come to terms with the rhetorical dimensions, in addition to the usual policy announcement as well (irrespective of whether or not monetary policy is reducible to rhetoric). The epistemological status of monetary theory has no direct bearing on the political and rhetorical dimensions that attend on what is expected of Bernanke when he makes his customary set of remarks. The problem of psychological expectations then is an impediment to developing a purely Newtonian approach to the formulation of monetary policy rules; which, incidentally, uses classical mechanics as its role model. 80

80 For a full-length examination of these and other issues related to the scientific basis, if any, of monetary policy by a Fed governor, see Mishkin, Frederic S. (2007). ‘Will Monetary Policy Become More of a Science?’ Finance and Economics Discussion Series, Divisions of Research & Statistics and Monetary Affairs, Federal Reserve Board, Washington D.C. This paper was originally written for a conference on monetary policy organized by the Deustche Bundesbank titled ‘Monetary Policy over Fifty Years,’ at Frankfurt, September 21, 2007. Mishkin identifies the nine key principles on which monetary policy is based at the very beginning of this paper (p.2). For a simple introduction to the concept of a monetary policy rule by a distinguished central banker, see Poole, William (2006). ‘The Fed’s Monetary Policy Rule,’ Federal Reserve Bank of St.Louis Review, Jan/Feb, pp. 1-12, available at:

http://research.stlouisfed.org/publications/review/06/07/Poole.pdf

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PTOLEMAIC RESIDUES IN MONETARY POLICY

In monetary theory, unlike physical theory, subjectivity as embodied in the notion of ‘confidence’ and ‘expectations’ does not emerge at the point of making a transition to the realm of quantum phenomena as the history of physics might demonstrate, but complicates the theory at the pre-Newtonian level itself. 81 We might posit of Newtonian theory with great confidence that it is not susceptible to the problem of either psychological confidence or expectations or even the rhetorical problem of articulation, but this is a claim that monetary theory is less likely to answer to. In other words, monetary theory continues to be haunted by a Ptolemaic residue of epicycles (if we wanted a pre-Newtonian analogy for a variant from the history and philosophy of science), and the economic actors must all be well-behaved to save the theory, which takes, more specifically, the form of ‘guiding expectations.’ The Fed, surely, is not to blame for this and therefore, I argue, that the Fed must not be excessively haunted either by its inability or by those of the community of monetary theorists from whose work it draws its modalities of policy making, to compile an exhaustive inventory of monetary policy rules that are either completely immune to the pressures which arise from the political process or which are so sound from both a conceptual and technical point of view that they can be expected to triumph the short-termism of the political process even if they can only guarantee success (as monetary policy is expected to do) in the long term. To get a sense of perspective on how far the Fed has moved on this, one has to only

81 An interesting account of how economics as a discipline has been shaped by the Cartesian-Newtonian paradigm is set out in Capra, Fritjof (1983). ‘The Impasse of Economics,’ The Turning Point: Science, Society, and the Rising Culture (New York: Bantam Books), pp. 188-233.

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consider the sense of disarray in monetary policy in the 1970s, where the Fed’s actions were governed by the so-called ‘Go-Stop’ policy.82

The underlying anxiety at play in making a much stronger case for monetary policy rules than is probably warranted by the extent of formalization of such rules, I am tempted to suggest, has more to do with the political economy of central banking rather than with anything else.83 The institutional manifestation of this anxiety pertains to the question of central bank autonomy; those who worry about the erosion 82 Goodfriend writes that ‘at the heart of the disarray in monetary policy practice in the 1970s was the tendency for a central bank like the Federal Reserve to pursue “go-stop” monetary policy. Go-stop policy was a consequence of a central bank’s inclination to be responsive to the shifting balance of public concerns between inflation and unemployment. The central bank would stimulate employment in the “go” phase of the cycle until the public became concerned about rising inflation. Then aggressive interest rate policy initiated the ‘stop’ phase of the policy cycle to bring inflation down, while unemployment rates moved higher with a lag. Public support for interest rate increases evaporated once the unemployment rate began to rise, so it was politically difficult to reverse a higher inflation rate.’ See Goodfriend, Marvin (2007). ‘How the World Achieved Consensus on Monetary Policy,’ NBER Working Paper Series, Working Paper 13580, National Bureau of Economic Research, Cambridge, available at:

http://www.nber.org/papers/w1358083 In the course of summarizing the extant literature in a note to determine the relationship between central bank independence and macroeconomic performance, Alesina and Summers, for instance, have examined whether the ‘median voter’ will want a central banker more ‘inflation averse’ than ‘himself.’

They conclude that while the median voter may want such a central banker in theory, the median voter is also simultaneously ‘time-inconsistent’ in practice and may therefore want to ‘recall the central banker, who, ex-post, is being too conservative on the inflation front.’ It is therefore necessary to protect the central banker and insulate him from the usual political pressures if he is to do his job properly: ‘insulating monetary policy from the political process avoids this problem and helps enforce the low inflation equilibrium. Without some degree of political independence, it would be impossible to appoint a central banker more inflation averse than a majority of voters, which is a socially desirable goal.’ It appears then that what the

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of this autonomy under the pressures of the political process or the demands of election cycles fantasize on the possibility of resisting such pressures once and for all by arguing that monetary theory is nothing short of a science or as close as it is possible to get to the scientific realm in the social sciences. Monetary policy however does not need to be an exact science since there are other ways of justifying central bank autonomy that are less exacting from an epistemological framework, even given the desire to develop a theory that is as exact and rigorous as possible from a technical point of view. One such median voter needs protection from is not inflation per se, but from himself, i.e. from his own time-inconsistency since he wants to have it both ways without recognizing the necessary trade-offs that structure the underlying conceptual structure of monetary policy. While this problem of the median voter’s inconsistency has percolated sufficiently into the literature, another aspect of this paper that should be highlighted is the relationship between this time-inconsistency problem and the monetary tools that central bankers need to respond to it. Should they focus on the development of monetary policy rules or should they aim to preserve as much discretion as possible? As the authors put it, ‘our findings also have implications for the ongoing debate over the optimal rules governing monetary policy. Most obviously they suggest the economic performance merits of central bank independence. More subtly, they raise questions about the benefits of rule-based monetary policies. Advocates of rule-based policies typically stress that they avoid dynamic consistency inflation. The findings here suggest that it is possible for nations to achieve these benefits without setting a monetary rule by insulating the central bank from political control. While it is possible that rule-based performance would be superior to discretionary performance on stabilization grounds, Summers (1988) notes a number of reasons why this is unlikely including unforeseen events and the possibility of an economy getting trapped in the neighborhood of a suboptimal equilibrium around which stabilization would be undesirable.’

See Alesina, Alberto and Summers, Lawrence H. (1993). ‘Central Bank Independence and Macroeconomic Performance: Some Comparative Evidence,’ Journal of Money, Credit, and Banking, 25(2), pp. 151-152 and p. 159, respectively. An interesting analysis of the Summers-Alesina paper and the different dimensions of the relationship between central bank independence and macroeconomic performance is available in Hafer, R. W. (2005). ‘Central Bank Independence,’ The Federal Reserve System: An Encyclopaedia (Westport and London: Greenwood Press), pp. 52-55.

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argument is that - other things being equal – central banks can focus better on long-term price stability, and be responsive to the demand for credit-led growth, or concentrate only on the former (depending on the economy in question), if they do not have to focus on a range of economic prescriptions like fiscal policy must do.84 That alone is sufficient justification for central bank autonomy without necessarily having to invoke a favorable epistemology to guarantee its standing in the political economy of capitalism, especially when there is a residual element of socialist preoccupations in the economy as was the case

An interesting case study in this context is that of New Zealand, where the Reserve Bank Act of New Zealand (1989) made it not only possible for the Reserve Bank of New Zealand to adopt an explicit inflation target, but stick by it; the authors of this study conclude that central bank autonomy made it possible for a ‘decline of 4.2 percentage points in its average inflation rate.’ Incidentally, the inflation rate in New Zealand before its central bank was granted independence was as high as 18% in the 1970s. See Carlstrom, Charles T. and Fuerst, Timothy S. (2006). ‘Central Bank Independence: The Key to Price Stability?’ Economic Commentary, Federal Reserve Bank of Cleveland, available at: http://www.clevelandfed.org/research/commentary/2006/0901.pdf84 In other words, it is enough if theorists of monetary policy work at the level of ‘consensus’ rather than worry about how exacting a science monetary policy actually is. The important development really in developing central bank credibility and, by implication, the legitimization of its autonomy in the realm of policy making lay in the fact that, as Goodfriend points out, ‘monetarist economists led by Milton Friedman, Karl Brunner, and Allan Meltzer worked beginning in the 1960s to show that a central bank had the monetary policy tools to act decisively against inflation.’ They did do so, in Goodfriend’s assessment by doing the following: ‘First, monetarists assembled international evidence that even if short-term inflation can be affected by many factors, long-term sustained inflation is always associated with excessive money growth. Second, they developed the theory of money demand and supporting econometric evidence to show that control of money is both necessary and sufficient to control the trend rate of inflation. Third, they argued that a central bank could exercise sufficient control over money to control inflation through its monopoly on currency and bank reserves, even if fluctuations in the demand for money were hard to predict. These arguments may now seem self-evident, but they were highly controversial at the time.’ See Goodfriend, Marvin (2007). ‘How the World Achieved Consensus on Monetary Policy,’ NBER Working Paper Series, Working Paper 13580, National Bureau of Economic Research, Cambridge, available at: http://www.nber.org/papers/w1358

For a similar account on the monetary framework that central bankers are dependant on in the aftermath of Friedman’s work, see Bernanke, Ben S (2003). ‘Friedman’s Monetary Framework: Some Lessons,’ available at: http://www.dallasfed.org/research/pubs/ftc/bernanke.pdf

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when the Blair-Brown duo made a case for granting autonomy to the Bank of England as a part of the policy reforms that helped New Labour to come to power in the United Kingdom in the late 1990s.85

Furthermore, one can also argue that central bank autonomy is linked to its regulatory function since it has supervisory authority over banks in the United States.86

MONTAGU’S REFUSAL TO EXPLAIN

Bernanke, interestingly enough, begins his account of the framework that he helped to develop for the US Fed by comparing it to that of Montagu Norman’s refusal to explain much when he headed the Bank of England between 1921-1944. I will start therefore by sign-posting Bernanke’s invocation of Monatgu Norman’s maxim (‘never explain, never excuse’) as a way of demonstrating how far Fed authorities have come in this regard. Norman’s philosophy was motivated by the desire to maintain a mystical air to the modalities of making and articulating monetary policy, which he felt was beyond the ability of the public to understand. While cynics might maintain that the public at large find anything with technical content difficult to understand in the larger sphere of government and that this is not necessarily reducible to monetary policy, the significance of Bernanke’s arguments in favor of greater transparency in Fed communications arises from the fact that the supposed indifference or inability of the public at large to understand the goings on within the temple is no excuse for Fed governors to refrain from reaching out. The willingness to share, educate, and provide timely and useful information to both professional Fed watchers and the educated layperson is a part of a larger project to promote a hygienic attitude to the modalities of governance when the interests of the public can be affected by the activities of institutions. The Fed’s approach to communications then is 85 For an account of the role played by the US Fed in this and the relationship between the Blair-Brown duo and Chairman Greenspan in working out the modalities for granting autonomy to the Bank of England, see Greenspan, Alan (2006). The Age of Turbulence (London: Allen Lane, Penguin Books), pp. 282-284.86 See Bernanke, Ben S. (2007). Chairman’s Remarks at the Allied Social Science Association Annual Meeting, at Chicago, January 5, titled ‘Central Banking and Bank Supervision in the United States,’ BIS Review, 1/2007, pp. 1-8, available at:

http://www.bis.org/review/r061018a.pdf

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symptomatic of its underlying commitment to both improving the quality of governance of the Fed as an institution, and in providing thought leadership in the domain of monetary policy. After all, there is no real reason why the Fed, for instance, should not take the lead in the articulation and formulation of monetary policy rather than respond to developments in monetary theory from academic departments and think-tanks.87 Promoting and formalizing the modalities of Fed communications might be the first step in doing so irrespective of whether such a project in knowledge and theory development can be brought to fruition.88

87 For a succinct account of the differences though between how academics and central bankers think about monetary policy, see Issing’s early reflections on this theme from his time as a Member of the Board of the Deustche Bundesbank.

Issing’s argument is that the temperamental differences that govern the underlying modalities of monetary theory as opposed to monetary policy, in a sense, force us to revisit the traditional distinction between theory and practice in the history of philosophy going way back to Aristotle. The basic problem at hand is the fact that ‘monetary policy, just like other fields of human activity, always involves (in part) a mismatch between accumulated learning and the need to take specific action. In other words, the necessity to act invariably exceeds the measure of our knowledge. But in the field of monetary policy, in particular, it is not easy to define ‘action.’ Let me put it another way: if a “passive” monetary policy stance is called for rather than an “activist” approach, it is very hard to decide what such a policy should look like. The level of interest rates set by the central bank permits no direct conclusions.’ See Issing, Otmar, ‘Monetary Theory as a Basis for Monetary Policy: Reflections of a Central Banker,’ available at:

http://www_ceel.economia.unitn.it/events/monetary/issing.html 88 Poole calls attention to the relationship between the development of monetary policy in the form of formalizing monetary policy rules and the formalization of communication modalities in the context of a central bank by posing the following question: ‘How is it that the market and the Fed can so consistently agree on the interpretation of new information and its significance for policy actions, or lack thereof?’ Poole states candidly that ‘I don’t know the answer to this question,’ but goes on to add: ‘if we can formalize what the Fed does, it should be possible to further improve transparency and accuracy of communication with the market in the

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THE KEY QUESTIONS

What exactly is the frame work of communications that Bernanke sets out for the Fed? What is the work that is allocated to this framework? To what extent does this framework further the Fed’s mandate in setting monetary policy in the United States? And, more specifically, what is the role allotted in this framework to ‘inflation targeting’ - a term that is seen as almost synonymous with Bernanke’s theoretical contribution to monetary policy? What, finally, are the conclusions that Bernanke himself arrives at, in his own assessment, of the role of this communications framework, which he describes as ‘a work in progress,’ rather than one that has been formalized in its entirety? These then are some of the questions that I will address before moving on to consider the differences, if any, between Bernanke’s exposition and that which Kohn and Poole set out on the role of transparency and communications in monetary policy in the United States. Bernanke’s framework is an attempt to work-through the fact that the overall direction in central banking in the western world has been an attempt to respond to the demands of transparency as a prerequisite ‘to sound monetary policy making.’ The movement towards transparency has to some extent been helped by the growing sense of confidence in the community of central bankers to the formalization of monetary policy rules to some extent and the growing recognition that central banks must be buffeted from political pressures so that they can provide price stability and avoid the dangers that led to the Great Depression; which in the work of the monetarists is understood to have been caused by the inability of the Fed to act in a timely fashion.89

future. As successful as monetary policy has been in recent years, there is still a major agenda for the Federal Reserve and for scholars of monetary policy in assuring that the success continues’. While Poole celebrates this ‘convergence,” he understands that it ‘is still somewhat incomplete’ and that ‘its importance for a successful monetary policy should not be underestimated.’ See Poole, William (2000). ‘Confidence and Central Banking,’ The Fain Lecture in Celebration of George Borts’ Fiftieth Year as Professor of Economics at Brown University, Providence, Rhode Island, Oct 14, 2000, available at: http://stlouisfed.org/news/speeches/2000/10_14_00.html

89 It has been suggested that the Fed’s willingness to cut interest rates aggressively in response to the liquidity problems in the aftermath of the meltdown in the housing sector following the subprime crisis may have been influenced by the fact that Bernanke is acutely aware of the role played by monetary shocks as a causative factor during the Great Depression. Bernanke is not only a monetarist by training but

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Furthermore, the stability in process that has been witnessed in recent decades, and which Bernanke discusses in the context of “The Great Moderation” is cited generally as one of the great achievements of the monetarist paradigm in macroeconomics. This growth in confidence in the monetarist paradigm (at least within the province of central bankers) is an indication of their willingness to account for their own success in addition to the statutory requirements of the Federal Reserve System. These statutory requirements have led to a proliferation of communication and documentary opportunities for the someone who has spend a considerable amount of time in studying the causal factors that have been attributed in the literature to the Great Depression. After summarizing the debate, for example, between the monetarists (represented by Milton Friedman and Anna Schwartz) and the antimonetarists represented by Peter Temin on whether the main causative factor was ‘monetary contraction’ as asserted by the monetarists or nonmonetary factors such as the ‘famous autonomous drop in consumption in 1930,’ Bernanke considers the contribution made by the scholars who have written in recent decades on the role of ‘the operation of the international gold standard during the interwar period’ before concluding that the ‘new gold standard research allows us to assert with considerable confidence that monetary factors played a causal role, both in the worldwide decline in prices and output and in their eventual recovery.’ Bernanke’s conclusion after studying this debate is that contrary to the anti-monetarist’s argument, ‘exhaustive analysis of the operation of the interwar gold standard has shown that much of the worldwide monetary contraction of the early 1930s was not a passive response to declining output, but instead the largely unintended result of an interaction of poorly designed institutions, shortsighted policy making, and unfavorable political and economic preconditions. Hence the correlation of money and price declines with output declines that was observed in almost every country is most reasonably interpreted as reflecting primarily the influence of money on the real economy, rather than vice versa.’ See Bernanke’s Money, Credit and Banking Lecture, in Bernanke, Ben S. (1995). ‘The Macroeconomics of the Great Depression: A Comparative Approach,’ Journal of Money, Credit, and Banking, 27(1), pp. 3-4.

See also Friedman, Milton and Schwartz, Anna (1963). ‘The Great Contraction, 1929-33,’ A Monetary History of the United States, A Study by the National Bureau of

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Fed. Furthermore, Bernanke, in his testimony to Congress, (in the aftermath of his nomination as Chairman of the Fed by the Bush administration), pledged to expand and increase the efforts of the Fed that were already in place when he took over since continuity in such matters will not only serve the American economy well, but increase the level of transparency and democratic decision-making in the FOMC. This is because consensus building in the committee requires a commitment to communication both within and without the Fed.90

Economic Research, New York (Princeton: Princeton University Press), pp. 299-419 and Temin, who argues that the debate on causality in matters pertaining to the Fed’s actions is also a question of how economists define ‘action.’ For instance, Temin argues that a central question in these debates in understanding the causal factors in business cycles, in relation to the Fed, is to decide whether the actions of the Fed are ‘endogenous or exogenous?’

For Temin, ‘causes, in other words, do not have independent existences. They are functions of the models being used and the questions being asked. They are exogenous events whose identification is endogenous to intellectual inquiry.’ See Temin, Peter (1998). ‘The Causes of American Business Cycles: An Essay in Economic Historiography,’ NBER Working Paper Series, Working Paper 6692, National Bureau of Economic Research, Cambridge, available at: http://www.nber.org/papers/w6692

90 Goodfriend has argued that ‘to predict accurately the effect of an interest rate policy on longer-term interest rates and aggregate demand, a central bank must create an understanding in markets as to what a given short-term interest rate action implies for future short rates. For this task, communication is central to effective interest rate policy. Rational expectations reasoning teaches that ad hoc announcements can reinforce but not substitute for a genuine mutual understanding between markets and the central bank created on the basis of an explicit, credible low-inflation objective supported by a policy rule – a systematic articulation of how a central bank intends to move its short-term interest rate instrument in response to macroeconomic news to achieve that objective. Hence, the consensus model of monetary policy supports the worldwide drive to improve transparency in monetary policy practice.’ See Goodfriend, Marvin (2007), ‘How the World Achieved Consensus on Monetary Policy,’ NBER Working Paper Series, Working Paper 13580, National

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ECONOMIC PROJECTIONS

One of the most important genres of Fed communications in addition to those mentioned previously such as the Beige Book, the early release of the FOMC Minutes, etc., is the periodic release of economic projections which have both a quantitative and a qualitative dimension. Bernanke, in fact, invokes the word “narrative” quite categorically; there is a high probability that given his stature as an academic economist, he uses this word advisedly. I say this because as a former academic economist Bernanke must be well-aware of the connotations of this term, especially in the context of the debates that surrounded the “rhetoric of economics” movement (that is associated with those who work on areas like persuasion and the rhetorical construction of economics).91 While monetary theory, as a rationalist discourse, is a far-cry from these fringe movements in economics, Bernanke doesn’t mind the possibility of at least alluding to these developments even if he does not go out of his way to embrace them.92

Bernanke however is quite subtle in signaling these developments and must be read carefully if we are to understand what exactly he means by the problem of narrative; especially, when it is considered as a guide to the set of economic projections that are routinely released by the Fed. The projections in question have essentially two dimensions; Bureau of Economic Research, Cambridge, available at: http://www.nber.org/papers/w13580

91 See McCloskey, Deirdre N. (1998). The Rhetoric of Economics (Madison: University of Wisconsin Press).

92 After making a scholarly survey of the different theories of the firm, in the context of economic sociology, Nohria and Gulati argue that it is now time to think through the structural tension between the rhetorical and rational dimensions within and without the structure of the firm.

Some of their insights on the relationship between the firm and the environment in which it operates are also, by extension, relevant in understanding how the Fed is rhetorically embedded in society.

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the members of the FOMC will release independent projections on a range of indicators such as ‘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),’ and furthermore, ‘participants will now provide their projections for overall inflation.’ This practice of independent projections and evaluation continues under Bernanke, but, as he puts it, ‘following past practice, we will publish the central tendency and the range of the projections for each variable and each year.’ This dual strategy is possible precisely because the data is both qualitative and quantitative. The central tendency pertains to the quantitative dimension, and the “narrative” evaluation, and ‘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 policy makers.’ There are other dimensions to the narrative dimension to these economic projections in monetary policy making to which I will return in a moment, but I can’t help but remark that the proliferation of opinions that is both summarized and averaged, so to speak, is quite interesting because it helps us to understand the differences between individual narratives and those of the FOMC as a whole.93 The relationship that

See Nohria, Nitin and Gulati, Ranjay. ‘Firms and Their Environments,’ The Handbook of Economic Sociology, edited by Smelser, Neil J. and Swedberg, Richard (1994). New York, Russell Sage Foundation, Princeton: Princeton University Press, pp. 529-555. 93 The relationship between the structure of monetary policy committees and the changes that this would necessitate in forging the right communications strategy is discussed in detail by Alan Blinder, a former Vice Chairman of the Fed. Blinder argues that central banks are precoccupied with two audiences when they communicate: the public at large and financial markets. The objective of central bank communication is to teach markets to anticipate and learn to think along the modalities that characterize central banks. Since most central banks (with the notable exceptions of those in Canada and New Zealand) think in committees, it becomes necessary to understand the typology of monetary committees that are usually to be found in central banks. The three relevant types are the collegial committee, the genuinely-collegial committee, and the autocratically-collegial committee. Furthermore, there is a growing tendency to rely on decision-making by committees in monetary policy

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Bernanke spells out between the narrative and the minutes of the FOMC, as a genre, is important since the time-frame is not the same. The minutes have a short-term focus while the narrative has a medium-term perspective. There are also cautionary strictures built into these narratives; hence they ‘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.’ To appreciate the enormity of the communication task here; consider a with the implicit assumption that this is somehow ‘superior in principle.’ Not only then do committees dominate the show, but committees are expected to promote and prize diversity in their structure since the other implicit assumption is that ‘diversification pays.’ The structure of committees also determines, in a sense, the structure of documentation that accompanies the communication strategy. The generic differences between postmeeting statements and the role of minutes are crucial in this regard: ‘If the statement is very spare, then much of the burden of explanation falls on the minutes, which must therefore convey a great deal of information. (This is the FOMC model.) But if the immediate statement is sufficiently clear and detailed, no one but historians will be much interested in the minutes, which become available only weeks or months later, if ever. (This may approximate the model of the ECB, which issues no minutes). And, finally, there is the question of who should speak on behalf of the central bank. Should it be only the chairman or should it be a plurality of voices albeit with the caveat that what they say is not necessarily the opinion of the monetary committee?’

These then are some of the questions and problems considered in Blinder, Alan and Wyplosz, Charles (2004). ‘Central Bank Talk: Committee Structure and Communication Policy,’ at a session on Central Bank Communication, ASSA meetings, Philadelphia, January 9, 2005, available at: http://www.aeaweb.org/annual_mtg_papers/2005/0109_1015_0702.pdf See also Blinder, Alan (2006). ‘Monetary Policy by Committee: Why and How?’ DNB Working Paper, No.92/2006, De Nederlandsche Bank, available at:

http://www/dnb.nl/dnb/home/file/Working/20Paper%2E%2092_2006_tcm47

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simple analogy from another institution, the Supreme Court. Think of an elaborate narrative where each of the nine members has the room to state an individual opinion, and where a method has been worked out to present the central tendency in a given judgment, and where information that is provided in commentaries on the decision has the attributes listed above, including ‘qualitative information’ along with a discussion of ‘projection errors.’ That would not only be truly extraordinary as a form of narrative documentation, but leave professors of constitutional law and legal history with little or no work to do since an enormous amount of self-reflexivity has now been built into the system both at the level of decisions arrived at, and the underlying methodological strictures, which constitute the logical path followed in the act of judicial decision-making. Imagine, furthermore, a situation where independent dissents are also allowed and extensively documented as a part of the case narrative. This analogy will, I hope, give the reader a glimpse of the scope of this set of narratives as a guide to the economic projections provided by the FOMC. Bernanke fans will no doubt want to read these narrative guides to economic projections like law professors who sift through landmark opinions to identify the obiter dicta, if any, of their favourite judges.

THE FUNCTION OF ECONOMIC PROJECTIONS

Now that we have discussed the generic structure of the economic projections, and their accompanying narratives, and its relationship to FOMC minutes, we need to understand the functions that they represent. The term that Bernanke invokes at this juncture is ‘enhanced projections.’ He then sets out to list the ‘benefits’ of such enhanced projections and the uses that the public at large can make of these. There are essentially three benefits that Bernanke calls attention to. In Bernanke’s formulation, they serve ‘as a forecast, as a provisional plan, and as an evaluation of certain long-run features of the economy.’ There is no pretence whatsoever that economic forecasts can capture the future in an unproblematic way. As Bernanke is at pains to explain, ‘forecasting is a highly uncertain enterprise,’ and, that furthermore, in what can seem a shocking admission, at first sight for the uninitiated, ‘the only economic forecast in which I have complete confidence is that the economy will not evolve along the

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precise path implied by our projections.’ The task of economic projections then is not as instrumental as the layperson might think. In Bernanke’s formulation, it is an opportunity to think through the uncertainty that haunts all attempts to project into the future from what we know about the trends in the present. Bernanke then is haunted, quite literally, by the dangers of projection - be it in the psyche or in the economy! What comes to the rescue of the FOMC then is that it is pre-occupied with forecasts in the medium-term rather than in the short-term. The advantage in sharing these narratives with the public is that they will be able to appreciate the underlying coherence, or lack thereof, of policy prescriptions by both individual members and by the FOMC as a collective body of experts. Bernanke is not pushing a correspondence theory of truth here but one of coherence: ‘The public will also be better able to judge the extent to which the Committee’s rationale is reasonable and persuasive.’ While the emphasis on the italicized items is mine, the overall thrust of Bernanke’ s own arguments both in form and content tends to follow the attributes that he identifies in making public the Committee’s deliberations. The extended projections are also important because they can serve as ‘a plan for policy.’ This is especially the case since the Fed has a dual, statutory mandate: it must focus on both price stability and increase employment unlike central banks elsewhere which need but focus on fighting inflation. The extended projections then can push the FOMC’s quest for greater ‘transparency, predictability, and accountability.’ The challenge in getting these projections right rises from the fact that the Fed cannot focus on price stability to the exclusion of maximum employment: it has to be able to balance the demands inherent in both these objectives. Hence, it becomes difficult to aim at zero inflation; the Fed therefore targets as low an inflation rate as possible. And since households are more interested in the so-called ‘headline inflation,’ the FOMC uses this indicator to evaluate its performance over the long term, and so-called ‘core inflation,’ which excludes food and energy prices, to evaluate its performance over the short term. Fed projections therefore must account for both. The FOMC also makes projections on indicators of growth even though it knows that in the long run monetary policy has less impact on growth rates than, say, entrepreneurial activities.

INFLATION TARGETTING

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One of the more important ideas in monetary policy that Bernanke is interested in is ‘inflation targeting,’ especially in the context of the Fed’s communications framework, since this term highlight’s the Fed’s confidence in the tools provided by developments in monetary theory in recent years.94 Bernanke calls attention to two aspects of inflation targeting: the need for ‘an explicit numerical target or target range for inflation, and a high degree of transparency about forecasts and policy plans.’ Inflation targeting, Bernanke argues, must not be seen as a loss of focus on the Fed’s ‘dual mandate,’ since the current practice in the community of central bankers is to be ‘flexible,’ while evaluating policy options. Inflation targeting, in a sense, has become the default option today in central banking since even in the absence of an explicit numerical target that the Fed can announce, the consensus in monetary policy is to maintain ‘low and stable inflation over time.’ Central banks, which focus on inflation targeting to the exclusion of considerations of economic growth and maximum employment, will use a simpler communications strategy since what is actually at stake is an announcement on the numerical representation of a policy objective; this however is not the strategy adopted by the Fed since its dual-mandate makes it much more difficult to make a straight-forward announcement.95 Instead, as explained previously, the economic 94 For a simple introduction to the concept of inflation targeting, see Poole, William (2006). ‘Inflation Targeting,’ Federal Reserve Bank of St.Louis Review, May/June, 88(3), pp. 155-163, available at: http://stlouisfed.org/news/speeches/2006/02_16_06.htm

For a more extended panel discussion featuring Ben Bernanke and Don Kohn of the U.S. Fed and Otmar Issing of the European Central Bank (ECB), see ‘Panel Discussion,’ in Federal Reserve Bank of St.Louis Review, July/Aug 2004, 86(4), pp. 165-183, available at:

http://research.stlouisfed.org/publications/review/04/07/PanelDisc.pdf95 Nevertheless, as Mishkin implies, in a paper written as early as 1988 before inflation targeting had ‘arrived’ in a big-way in monetary policy in the United States, the US Fed has been able to reach out and communicate because it has been influenced by the strategies adopted by central banks that work with a more specific inflation target. These central banks, he writes, encourage more ‘public speeches on their monetary policy strategy’ by their policymakers. Furthermore, ‘inflation-targeting central banks have taken public outreach a step further: not only have they engaged in extended public information campaigns, even engaging in the distribution of glossy brochures, but they have engaged in publication of ‘Inflation Report’ type documents (originated by the Bank of England).’ See Mishkin, Frederic S. (1988). ‘Central Banking in a Democratic Society: Implications for Transition Countries,’

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projections of both individual members and the FOMC as a whole are released. Furthermore, the membership of the FOMC is derived from diverse sources making it much more likely that it will adopt ‘an eclectic approach,’ reducing thereby the dangers inherent in ‘a single viewpoint or analytical framework.’ Bernanke concludes his account of the Fed communications model by calling it ‘a work in progress’ and hopes that by providing a ‘diversity of perspectives,’ it ‘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.’96 The commitment that drives the Fed though is the need to ‘improve the accountability and public understanding of U.S. monetary policy making.’ It is easy to make the mistake of underestimating the scope of not only what the

available at:

http://www0.gsb.columbia.edu/faculty/fmishkin/PDFpapers/DEMOCRAT982.pdf96 This is the case with the ECB as well. Otmar Issing, the Chief Economist of the ECB, highlights precisely this dilemma of how a central bank should go about capturing not only the relevant data; but, more importantly, the analytic framework necessary to model the data in order to make policy recommendations on a sound empirical basis. The basic challenge here is to be able to formulate monetary policy under conditions of uncertainty. What does that mean for a central banker? What it essentially means is that there are at least two sources of uncertainty: the data and the analytic model. And, ‘even if there were a consensus on a suitable model of the economy, considerable uncertainty would remain regarding the strength of the structural relationships, i.e. the value of parameters, within that particular model.’ Unlike the United States, which has experienced a certain robust continuity in terms of the underlying analytic parameters, the complications in the EU monetary area represent an even bigger problem in terms of uncertainty: ‘Inevitably,’ argues Issing, ‘available parameter estimates are affected by data imperfections and by the particular econometric techniques that are employed for estimation. An even more fundamental problem is that parameters vary over time as a result of structural change in the economy. Uncertainty about parameters confronts all central banks, but seems particularly relevant for empirical models of the euro area, since their estimation has to rely on historical back data which stem from the period prior to the formation of Economic and Monetary Union (EMU), when the member countries experienced monetary policy regimes within different monetary policy regimes and data were not always sufficiently harmonise’. See Issing, Otmar (2002). ‘Monetary Policy in a World of Uncertainty,’ Economic Policy Forum, Fondation Banque de France, Centre d’Etudes Prospectives et d’Informations Internationales CEPII, Université Aix-Marseille IDEP, Paris, 9 December, available at:

http://www.banque-france.fr/gb/findatio/telechar/issing.pdf

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Fed has attempted to do under Bernanke; but overlook, more fundamentally, the developments in monetary policy from which the Fed has derived the confidence to embark on this project of making its internal debates, and policy recommendations, available to a wider public.97 The modalities involved in communicating policy decisions to a wider public by central banks in the U.S. and elsewhere, is a fascinating topic in itself especially since it is not only tied up with the fate of monetary policy as such, but also in how monetary policy is linked to the academic debate on whether or not macroeconomics is a science.98 While a full-fledged examination of this question is beyond 97 Goodfriend argues that it was in the year 1994 that there was a fundamental change in how the Fed began to communicate with the public and this was a result of the tightening of credit in that given year. ‘In February 1994,’ he writes, ‘the Fed began to announce its current federal funds rate target immediately after each Federal Open Market Committee Meeting, the first in a series of steps to improve communication. The Fed had managed interest rates secretly for most of its history…In part this was because the Fed earlier had lacked a coherent monetary policy strategy, but by 1994 it had developed a set of practical strategic and tactical monetary policy principles based on targeting low inflation. And it was increasingly difficult for the Fed to obfuscate interest rate policy because academics had begun to discuss Fed monetary policy in terms of interest rates. Expecting great scrutiny for its first tightening of monetary policy since 1989, the FOMC decided that it would be counterproductive to try to hide its current federal funds rate target from the public. In time, the public would come to see monetary policy through management of the federal funds rate as a stabilizing force for inflation, employment, and long term interest rates.’

See Goodfriend, Marvin (2007). ‘How the World Achieved Consensus on Monetary Policy,’ NBER Working Paper Series, Working Paper 13580, National Bureau of Economic Research, Cambridge, available at: http://www.nber.org/papers/w13580

98 Economists such as Ed Prescott have argue that it is indeed possible for macroeconomists to make a stronger claim on the scientific basis for macroeconomics than before, but as pointed out earlier, the consensus in monetary policy is good enough on pragmatic grounds of policy making for central bankers to speak with confidence. Nevertheless, it is worth noting that a Nobel laureate like Ed Prescott, who is incidentally affiliated to the Federal Reserve Bank of Minneapolis, can state categorically that while traditionally macroeconomics was seen as a

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the scope of this essay, suffice it to note at this juncture that this question continues to remain pertinent to the challenge of developing a communications framework for central banks. The confidence that policy recommendations command amongst both professional Fed watchers and those in the financial community, and the problem of inflation expectations revolves ultimately around the theoretical structure of monetary theory and the theoretical framework of macroeconomics per se. It has been argued that the reluctance of central bankers to communicate clearly until recent years itself is linked to the anxiety that they did not have a theoretically secure platform from which they could speak (as Bernanke’s initial invocation of Monatgu Norman makes clear). There is a growing interest in this problem amongst theorists of monetary policy today since the relationship between the formulation and articulation of monetary policy is not always clear. Hence, as Bernanke is at pains to point out: ‘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.’

DON KOHN ON FED COMMUNICATIONS

In this part of the essay I will analyze the framework set out by Vice-Chairman Don Kohn on the relationship between monetary policy transparency and communications, and the need to develop a ‘global perspective’ on this issue.99

separate endeavour compared to neoclassical economics, it has now become possible because of the contributions made by him and Finn Kydland to contemplate the possibility that a methodological revolution is underway in macroeconomics and that the story of their careers, in a sense, is about ‘how macroeconomic policy and research changed as a result of the transformation of macroeconomics from constructing a system of equations of the national accounts to an investigation of dynamic stochastic model economies.’ See Prescott, Edward C. (2006). “Nobel Lecture: The Transformation of Macroeconomic Policy and Research,” The Journal of Political Economy, 114(2), p. 203.

99 Kohn, Donald L. (2008). ‘Recent and Prospective Developments in Monetary Policy Transparency and Communications: A Global Perspective,’ National Association for Business Economics Session, Allied Social Science Associations Annual Meeting, New Orleans, Louisiana, January 5, available at:

http://www.federalreserve.gov/newsevents/speech/kohn20080105a.htm

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I want to try and relate Kohn’s address to that of Bernanke and see what supplementary features and differences, if any, between these two attempts at setting out a communications framework for the Fed can be unearthed. This is worth doing not only because Kohn headed the subcommittee that tried to formalize the communications framework, as Bernanke points out in his address; but also because Kohn has been a professional central banker all his life, and is not an academic who moved to the Fed like Bernanke. Kohn, in other words, will help us to see what the problem of communications is like for a Fed insider. Interestingly, Kohn has his own set of preoccupations with this problem of the ‘inside/outside’ perspective - not only in the context of communications; but, more generally, in terms of the formulation of monetary policy and monetary policy committees, and how diversity in the FOMC can be harnessed for generating better policy options albeit under the leadership of the Chairman.100 The occasion for Kohn’s address is an attempt to respond to a specific development. How exactly should the FOMC communicate with the public given its decision to expand its medium-term forecasts?

FED COMMUNICATIONS & EXPECTATIONS

Kohn begins his account of the role and importance of communications in central banking by arguing that communications play a role in shaping expectations, and that expectations in turn determine choices that households and other economic agents will make when they are called upon to make decisions. The success of the Fed in seeing 100 See Kohn, Donald L. (2008). ‘Expertise and Macroeconomic Policy, Comments on “Insiders versus Outsiders in Monetary Policy-Making,” by Timothy Besley, Neil Meads, and Paul Surico,’ at the American Economic Association Session, Allied Social Science Associations, Annual Meeting, New Orleans, Louisiana, January 4, available at:

http://www.federalreserve.gov/newsevents/speech/kohn20080104a.htm

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through its monetary policy objectives then depends on the co-operation of a large number of those who will make decisions in response to what they hear from it by way of policy announcements. It is therefore necessary to communicate in a way that will educate those who are in receipt of such communications, especially in terms of the expectations that they will carry home as economic agents. Good communications serves then as a way of both educating economic agents and in shaping their expectations about economic outcomes within a given time-frame. But, communications can only be ‘a complement to good policy, not a substitute for it.’ Therefore it cannot substitute for deficits, if any, in the analysis that serves as the run-up to formulating monetary policy. This, incidentally, is not Kohn’s first foray in formalizing the relationship between Fed communications and its impact, if any, on the market(s). He had attempted a similar exercise some years earlier, and had come to the conclusion that the impact of central bank talk on the markets is easier to estimate in monetary regimes that focus on inflation targeting, and that the impact is greater if the Fed’s pronouncements were on areas directly under its jurisdiction. Kohn however found no evidence that a central bank could impact on asset valuations. This is an important finding since the Fed is often blamed for those aspects of the economy’s performance even if it is not directly under its jurisdiction.101 It also

101 Kohn and Sack came to the conclusion that it is not within the province of the Fed to ‘talk down’ asset valuations that it felt were excessive, and that investors, in general, were unaffected by such pronouncements. In other words, the Fed could not have ‘damped the apparent stock market bubble of the late 1990s without actually adjusting monetary policy…This last finding is also consistent with the overall conclusion of studies of foreign exchange market intervention and changes in margin requirements – two longstanding techniques that central banks have used to signal their assessment that asset prices had strayed from fundamentals. These studies generally show that these efforts to influence asset prices are ineffectual unless they are expected to be backed up by changes in the stance of monetary policy. Apparently investors have not taken the Chairman’s comments on equity valuations as a signal that policy will be adjusted directly in response. Indeed, asset prices per se are not in the legislative mandate of the Federal Reserve except to the extent that they affect macroeconomic stability, and hence the FOMC typically pays attention to asset prices only in the context of economic outlook.’ We however cannot infer from the lack of impact on asset valuation that Fed talk has no impact whatsoever. Fed communications do have an impact within the ambit of monetary policy and the most important role of communication is to shape ‘expectations.’ These expectations then revolve around two important aspects: ‘policy actions and economic conditions.’ Furthermore, as the authors point out in their conclusion, ‘statements and policy actions can serve as effective substitutes for one another, at least in the short run.

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appears that it may be necessary for central bankers to manage expectations effectively on what monetary policy can or cannot do since the period of stability appears to be coming to an end.102 The market, in turn, can provide effective feedback if it understands the Fed’s objectives and intentions and the monetary framework in which all the actors must think through these policy objectives, and measure outcomes to take corrective action whenever necessary. Furthermore, working out a communication strategy can help the FOMC develop greater clarity in its ‘internal deliberations.’ Some of the questions that Indeed, a credible central bank can probably achieve nearly the same result by implementing a policy action by promising to implement that action at the next meeting.’ See Kohn, Donald L and Sack, Brian P. (2003). ‘Central Bank Talk: Does It Matter and Why?’ Festschrift for Chuck Freedman, Bank of Canada, August 25, 2003, available at:

http://www.federalreserve.gov/pubs/feds/2003/200355/200355pap.pdf

This is more or less the position that Bernanke takes in his turn. In an address on the relationship between asset-price ‘bubbles’ and what, if anything, monetary policy can do to address this problem, he argues that it is neither ‘desirable nor feasible’ for the Fed to function as an ‘arbiter of security speculation or values’. The Fed should focus instead on providing credit when necessary in order to ensure that there is sufficient liquidity in the market during a crisis (which is what it is doing now in the aftermath of the ‘sub-prime’ crisis). It is therefore not the task of the Fed to burst asset bubbles. In Bernanke’s own words: ‘I worry about the effects on the long-run stability and efficiency of our financial system if the Fed attempts to substitute its judgments for those of the market. Such a regime would not only increase the unhealthy tendency of investors to pay more attention to rumors about policymakers’ attitudes than to the economic fundamentals that by rights should determine the allocation of capital.’ See Bernanke, Ben S. (2002). ‘Remarks’ by Governor Ben S. Bernanke before the New York Chapter of the National Association for Business Economics, New York, New York, October 15, 2002, available at:

http://federalreserve.gov/boarddocs/speeches/2002/20021015/default.htm102 Lambert, an External Member, Monetary Policy Committee, Bank of England, argues that ‘there are two big problems with the idea that central bankers can manage economies along a path of smooth expansion. The first is that it’s not true; they have neither the knowledge, the tools, nor the authority to make this possible. And the second is that unless these perceptions are changed, monetary policy makers are going to get a good part of the blame when the great stability eventually comes to an end. That would be a threat to their credibility, and so to their ability to do their job.’ See Lambert, Richard (2006). ‘Central Bank Communications: Best Practices in Advanced Economies,’ Regional Seminar on Central Bank Communications,” Mumbai, 23 January 2006, available at:

http://www.bankofengland.co.uk/publications/speeches/2006/speech264.pdf

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Kohn addresses in the context of these internal deliberations of the FOMC include the following: What is the relationship between communication and transparency? Will transparency necessarily lead to better policy making?103 Or will transparency ‘inhibit the free give-and-take’ between members of the FOMC that is necessary to think through policy options and recommend good decisions?104 How should the FOMC go about explaining its policy decisions since it is possible to arrive at the same policy recommendation from different points of

Lambert’s call for caution is not without an important precedent. This is more or less what Friedman himself argued when, as he put it, ‘the elimination of economic uncertainty would promote healthy economic growth by providing a stabler environment for both individual planning and social action. But it would be no panacea. The springs of economic progress are to be found elsewhere; in the qualities of the people, their inventiveness, thrift, and responsibility, in public policies that gives a free field for private initiative and promotes competition and free trade at home and abroad. Mistakes in monetary policy can render these forces impotent. A stable monetary environment can give them an opportunity to be effective: it cannot create them.’ See Friedman, Milton (1959). ‘Rules versus Authority in Monetary Policy,’ in William, Harold R. and Woudenberg, Henry W. (1970). Money, Banking and Monetary Policy (New York: Harper & Row, 1970), p. 371.

103 One of the justifications for moving away from secrecy in the formulation of monetary policy to transparency is that there is no justification for holding back relevant information from the market in a democracy. There is a growing literature in monetary theory on the role of transparency in formulating and communicating monetary policy by both representatives of the Fed and by scholars working on the area in the last two decades. William Poole, the President of the Federal Reserve Bank of St. Louis is an avid speaker on this theme. Poole’s definition of transparency is nothing, but ‘shorthand for accurately conveying accurate information including all the information market participants need to form opinions on monetary policy that are as complete as possible.’ See Poole, William (2003). ‘Fed Transparency: How, Not Whether,’ at the Global Interdependence Center, Federal Reserve Bank of Philadelphia, Aug 21, 2003, available at:

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view, i.e., ‘based on different rationales.’ What are the recommended modalities in deploying a communications strategy in situations of uncertainty? Kohn’s conclusion at the end of these ruminations is that while communications is important; it is important to remember that an ‘ill-conceived communication policy has the power to harm the economy, and, even if that harm were to be realized, the policy could be difficult to alter.’

ENHANCED ECONOMIC PROJECTIONShttp://stlouisfed.org/newsd/speeches/2003/8_21_03.html.

And, furthermore, for Poole, there are three dimensions in the concept of transparency. The three dimensions are the following: ‘1) transparency about the objectives of monetary policy; 2) transparency about current monetary policy actions; and 3) transparency about expected future monetary policy actions.’ See Poole, William (2004). ‘FOMC Transparency,’ at the Ozark Chapter of the Society of Financial Services Professionals, Springfield, Mo., Oct 6, available at:

http://stlouisfed.org/newsd/speeches/2004/10_06_04.html

104 Ferguson adds an interesting twist to the problem of transparency by arguing that there is a significant difference between the role that transparency plays in the communications strategy of the Fed as opposed to the ECB, which ‘does not release minutes or transcripts and does not provide information on Governing Council votes.’ While at first sight this does not appear to be a good way of proceeding, Ferguson goes on to explain the rationale: ‘Rather than detailing the differing views of individual members, who might feel pressure to represent their national interests if their votes were made public, the ECB focuses on explaining the analysis behind the Governing Council’s consensus. In particular, the ECB follows its monetary policy meetings with a news conference in which the president reads a statement reflecting the Council’s deliberations and then answers questions.’ The other interesting difference between the Fed and the ECB is that the latter has to cater to the demands of making monetary policy for a host of nations: it has, in other words, ‘multinational status.’ And, finally, it must be remembered that the Fed’s ‘ongoing process of transparency may also reflect the highly developed state of our financial markets and a growing recognition that, against that financial backdrop, shaping the expectations of market participants can on occasion be an important adjunct to monetary policy.’

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Kohn then moves on to consider the role of ‘enhanced economic projections.’ I have already discussed these projections while summarizing Bernanke’s framework of Fed communications in Part II. Kohn and Bernanke are in agreement here on what the role of such enhanced economic projections should be. The aim of these projections is to provide more information than was hitherto made available by the Fed ‘about the FOMC’s medium-term outlook for the economy.’ The ‘forecast horizon’ in these enhanced projections is nearly double that of the previous economic projections and can span as many as three years. Extending these time spans makes it easier for the FOMC to comment on the structural dynamics of the economy; and its impact, if any, on ‘the conduct of policy.’ These enhanced projections will make it easier to differentiate ‘short-term shocks’ and long-term trends in prices. This differentiation is especially useful in the planning process. The projections also differentiate between ‘total consumer inflation’ and ‘core inflation.’ The former is a better indication of prices over the long term and the latter over the short term. While a projection forecast is defined as ‘each Committee member’s assessment of the most likely outcome for the economy,’ an additional feature of the enhanced projection forecasts is an attempt to understand if and why previous forecasts may have failed to hit the mark, and the learnings from that failure.105 The members of the FOMC

See the Remarks by Vice Chairman Roger W. Ferguson, Jr. at a European Central Bank Colloquium in Honor of Tommaso Padoa-Schioppa, The European Central Bank, Frankfurt, Germany, April 27, 2005, available at:

http://www.federalreserve.gov/BoardDocs/Speeches/2005/20050427/default.htm

105 Goodfriend’s comments on the role of the history of monetary policy and the function of the archive in this regard are quite interesting. ‘I have long felt that in order to be at all confident, persuasive, and effective in giving policy advice one needs to understand how the policy in question evolved over time…Indeed there is scarcely any other way for a central bank to improve monetary policy except by recognizing and evaluating the reasons for its past policy successes and failures and working to incorporate those historical lessons into current practice.’ See Goodfriend, Marvin (2007), ‘Elements of Effective Central Banking: Theory, Practice, and History,’ The RBI Archives Foundation Day Lecture, Silver Jubilee of RBI Archives, Oct 5, 2007, at the Reserve Bank of India, Mumbai, available at:

http://rbidocs.org.in/rdocs/Bulletin/PDFs/81160.pdf

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however are not asked, in the course of developing such forecasts, to provide for ‘an explicit numerical definition of price stability.’

DIVERSITY OF VIEWS

While it is true that members make assumptions about monetary policy, the FOMC does not release the ‘range or histogram for participants assumptions about appropriate policy, because it was concerned about the potential for unintended consequences of such a publication.’ This is especially the case during crisis-ridden situations; the FOMC will have to ask itself whether releasing a statement will cause undue alarm or calm the markets. The FOMC will also have to take the trouble to explain any unusual decisions or innovations that it might want to sign-post. Examples of such actions that Kohn calls attention to, from the year 2007, include ‘the reduction in the penalty on the primary discount rate in August and the inauguration of a Term Auction Facility in December.’ Other instances include situations when there is a substantial change in the ‘balance of risks’ that the markets must be informed of. The FOMC however has allowed a certain diversity of opinions to be expressed by members in situations like this since often ‘circumstances are changing quickly and are subject to many different analyses.’ The fond hope of the FOMC is that, by harnessing the diversity of views available, it can arrive at the ‘sound decisions’ that are necessary ‘to further the accomplishment of,’ as Kohn puts it, ‘our public policy objectives.’ This however does not mean that a specific policy path can be spelt out categorically by the Fed, or any other central bank. 106

BILL POOLE ON FED COMMUNICATIONS

One of the most prolific members of the FOMC on matters pertaining to the challenge of Fed communications, and the role of communication in promoting transparency in monetary policy and the functioning of the Fed, is William Poole.

106 See also Kahn, George A. (2008). ‘Communicating a Policy Path: The Next Frontier in Central Bank Transparency?’ Federal Reserve bank of Kansas City, Economic Review, pp. 25-51, available at: http://www.kc.frb.org/PUBLICAT/ECONREV/PDF/1q07Kahn.pdf

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This is a concern that he began to articulate as early as 1999, and has stuck by his advocacy since that time. Poole, incidentally, retired in February this year. This part of the essay will summarize Poole’s arguments on behalf of transparency and set out the framework that he terms the ‘full rational expectations macroeconomic framework.’ Poole’s account of this problem is interesting since he began as someone who took the problem of Fed communications for granted. He however understood, subsequently (after being appointed to the FOMC), that things were a lot more complicated than he had been given to understand; and that despite having devoted a considerable amount of time to the study of monetary policy as a macroeconomist based in the academy, there was a lot more that he had to learn through the experiential realm. Poole’s first major observation pertains to the ‘channels’ of communication. There are, broadly speaking, three channels that he sets out to examine: these channels pertain to the movement of personnel, ideas, and information. The basic problem in Fed communications pertains to the constraints that govern its ability to intervene in setting the interest rates for the federal funds rate. The problem though is that while the ‘Fed has substantial control over the federal funds rate in the short run, it has no lasting, or long-run, effect on the average level of rates if it is successful in achieving price stability. Over the long run, rates depend on the economic fundamentals of productivity growth, savings and so forth.’ Miscommunication between the Fed and the markets arise when markets are unable to anticipate when, and by what number of basis points, there will be a change in the Federal funds rate. The communication problem is compounded by the fact that the ‘Fed cannot explain to the market what the path for the federal funds rate will be, because the Fed itself does not know.’ The reason that the Fed cannot anticipate its own actions sufficiently relates to the fact that incoming data might be contradictory in terms of the parameters that will help the Fed to decide whether to ease or tighten the funds rate.

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The communications challenge then is linked to the underlying complexity in deciding what the policy will be, and in checking to see if the markets can take action on their own ‘making a Fed response unnecessary.’

ACADEMICS & POLICY MAKERS

Another channel of communication that is worth examining is the information that is exchanged between people who are moving in and out of the Fed since the there is a lot of interaction amongst these people. The Fed has always been on the look out for anecdotal information about the state of the markets and people with Fed experience have always been in demand in the markets. The interface between academic economists and policy makers has been important in the emerging consensus on monetary theory and monetary policy; both in the generation of research and in the dissemination of research.107 While price stability continues to be the primary preoccupation of the Fed, ‘there is now substantial agreement that the Fed can achieve its long-run policy goal by using the federal funds rate as the day-to-day guide for open market operations.’ Other influential sources of Fed communications pertain to forecasts, speeches, and testimonies by the Chairman, and other members of the FOMC. The actual announcement of the federal funds rate following the discussions amongst the members of the FOMC must be made with a lot of care. ‘The aim is always to figure out the most constructive thing to say to make policy more effective and not to confuse, even inadvertently, the markets.’ Since the actions of the Fed are closely watched, the markets can often anticipate changes in the federal funds rate. While a strong alignment between the markets and the Fed is a good idea, it may not always be possible to achieve one in order to reduce uncertainty. The importance of Fed communications then has to do with the fact that while there is an emerging consensus in monetary theory, theoretical matters are by no means settled and the

107 See also Goodfriend, Marvin (2005). ‘The Monetary Policy Debate Since October 1979: Lessons for Theory and Practice,’ Federal Reserve Bank of St.Louis Review, March/April, Part 2, pp. 243-262, available at:

http://research.stlouisfed.org/publications/review/05/03/part2/Goddfriend.pdf

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FOMC will, like any other body of experts, disagree on a number of policy issues.108

CLARITY & TRANSPARENCY IN MONETARY POLICY

While the Fed and the markets may not be perfectly in synch, Poole observes that the federal funds futures markets can often predict short-term interest rates. It was this observation that made it necessary for Poole to try and not only think about communications issues, but to link it up to the rational expectations framework in macroeconomics. Poole’s transition from being a professor to a policy maker meant that he had to think through the implications of the fact that no readily available monetary tool existed; and that furthermore it was not easy to explain monetary policy to audiences who probably have a craving for such a rule. Learning to communicate with the markets therefore becomes a part of developing economic stability in monetary policy. Poole therefore concentrates ‘on clear communication of policy decisions and their rationale’ rather than ‘attempt to convey the full range of debate’ at the time of the policy announcement. The modalities that he would like to see institutionalized include regularity and predictability since the former leads to the latter. Poole argues that while the Fed talk factor is important, it takes time to solve problems emerging from psychological expectations since often ‘there is nothing the government, or the Fed, can do about a problem in the short run except wait patiently for the problem to be resolved by market processes.’109 But, interestingly enough, it is the market’s success in being able to predict the Federal funds rate rather than failure in doing so that prompted the growth of the studies that focus on central bank communications. In order to promote regularity, predictability, and stability in the markets, it is important to push for transparency in Fed 108 See Poole, William (1999). ‘Communicating the Stance of Monetary Policy,’ at the University of Missouri-Columbia, Nov 4, 1999, available at:

http://stlouisfed.org/news/speeches/1999/11_04_99.htm

109 See Poole, William (2008). ‘From Professor to Policymaker: Emerging From the Shadow,’ at the Olin School of Business, Washington University, St. Louis, Missouri, November 15, 2002, available at: http://stlouisfed.org/news/speeches/2002/11_15_02.html

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policy and communications. By transparency, Poole means basically two things: the ‘what’ and the ‘why’ of a recommended policy action. The question that preoccupies him then is this: ‘How can Fed communications make monetary policy more effective?’ The significance of this question to the framework of rational expectations should then be clear. The older paradigm in monetary policy that is being replaced used to work on the assumption ‘that monetary policy effectiveness depends on taking markets by surprise and creating uncertainty.’110 This is the model that is being superseded in the new literature on central bank communications and the role played by transparency in this process. Furthermore, a common understanding of how the economy works on the part of both the Fed, and the markets, is presupposed in the model of macroeconomic equilibrium that is guided by rational expectations. And, finally, the arrival of new information from the market has implications for interest rates and can lead to an asymmetric situation, which the markets may see as an opportunity for a change in FOMC policy. It is therefore necessary, argues Poole, for the FOMC to communicate in ‘stock phrases to describe different situations.’ This, he believes, will ’clarity and therefore transparency,’ which will not be served if a policy statement by the FOMC is subject to many interpretations.111

MONETARY POLICY MUST BE PREDICTABLE

Fed policy, for Poole, must not only be clear, but it must be predictable. The lack of predictability can have dire economic consequences: significant examples of which include the Great Depression in the 1930s, and the Great Inflation in the 1970s-1980s respectively. In his interpretation of the modalities of communication that characterized the term of the previous Chairman, Poole argues 110 See Poole, William (2008). ‘How Should the Fed Communicate?’ at ‘The Future of the Federal Reserve,’ Center for Economic Policy Studies (CEPS), Princeton University, April 2, 2005, available at: http://stlouisfed.org/news/speeches/2005/2005/4_02_05.htm111 While I have had just about enough space in this part of the essay to set out Poole’s model of transparency, it is interesting to note that transparency in central banking has become a fast-growing area of research by academic scholars. See Carpenter, Seth (2004). ‘Transparency and Monetary Policy: What Does the Academic Literature Tell Policymakers?’ Division of Monetary Affairs, The Board of Governors of the Federal Reserve System, FEDS Discussion Paper No. 2004-35, available at SSRN: http://ssrn.com/abstract=594842

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that several significant developments can be listed as FOMC achievements. Examples of such developments include the following: the use of multiples of 25 basis points for determining the Fed funds rate from August 1989; the release of press statements following the conclusion of FOMC meetings starting with February 1994; the invocation of a formal target to determine the funds rate along with an inclusion of this rate ‘in the Directive to the System Open Market Account Manager,’ in August 1997; the formal indication of a ‘bias’ on whether or not the FOMC felt a change was necessary in terms of an increase or decrease of the Fed funds rate in May 1999; the introduction of the notion of ‘balance of risks’ in place of the previously announced language of ‘bias,’ details about the ‘the vote on the Directive and the names of the dissenting members’ in the statement released to the press following the FOMC meeting in January 2002; the introduction of the so-called ‘forward-looking’ languages as a clue to the probable changes; if any, to the funds rate in the next meeting of the FOMC in its press statement; and the earlier release of FOMC minutes to as short a period as three weeks after the meeting since the meeting of January 2005. These then are some of the significant achievements from the years that preceded Bernanke’s tenure (in developing a greater degree of transparency in the FOMC compared to the earlier notion that monetary policy must maintain a sense of mystique and secrecy). 112

THE NEW TRANSPARENCY

The new transparency is a key element in central bank credibility and presupposes that transparency will be rewarded by the market’s response, since the macroeconomic framework of ‘rational expectations’ that Poole is pitching for incorporates the idea that ‘markets do reflect efforts of private agents to look ahead, however imperfectly they may be able to do so,’ and, that furthermore, this process ‘certainly includes forming expectations as to what policymakers will do.’ The hope is that transparency will not only shore up central bank credibility but increase the public’s trust in the bank as an institution. One element of this trust is that banks are immune to the political process and function through rules more than political

112 See Poole, William (2005). ‘How Predictable is Fed Policy?’ University of Washington, Seattle, Oct 4, 2005, available at: http://stlouisfed.org/news/speeches/2005/10_04_05.htm

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discretion. While monetary policy rules may not have been widely available, the success of the Taylor rule in the history of monetary policy is a notable example of something that ‘fit experience pretty well, and continued to do so after 1933. Furthermore, as Poole points out, ‘some version of the rule became the standard way of closing macroeconomic models.’ The applicability of the rule however was not tested as extensively as a macroeconomist might have liked it to be since ‘the Federal Reserve has not followed the Taylor Rule closely, or any variant of it or other rule.’ So while the Taylor Rule continues to be an important piece of theoretical innovation in the attempt to construct monetary policy rules, ‘there remained and remains today a gap between what the Federal Reserve actually does and the notion of a policy rule embedded in the abstract models.’ Poole concludes by arguing that despite deviations from the Taylor Rule, the Fed continues to behave in a way that is not only predictable, but is almost ‘rule-like’ in its articulation of monetary policy. Poole’s evidence that this is, in fact, the case is drawn from the ‘Fed’s analysis of the significance of statistical data based on detailed information that helps to distinguish transitory disturbances, to which the Fed ought not and does not respond, from genuinely new information to which the Fed should and does respond.’ Furthermore, since the Taylor Rule works with ‘a specified inflation target,’ it has become necessary for central banks to work towards greater clarity in the articulation of this target. While inflation targeting has not been specifically adopted by the US Fed, the general expectation was that Bernanke might push in that direction given his fondness for this notion, albeit with some flexibility given the Fed’s dual-mandate of preserving both price stability and maximizing employment; which by common consensus, is defined as ‘complementary’ rather than as ‘competitive.’

COMMITTING TO FED COMMUNICATIONS

The advantage of making a policy commitment to Fed communications, for Poole, lies in the fact that sticking to the demands of the dual-mandate in the context of a rational expectations framework demands ‘an improvement in the clarity of internal deliberations’ since the FOMC must clarify its own intentions before making it known to the market. In Poole’s formulation: ‘We need to know what we want to say before we try to say it.’ The most important communication challenge for the FOMC however is the problem of

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‘forward guidance’ in policy matters given that the guidance is based on the data available at the time of its formulation. In other words, the FOMC must ensure that forward guidance is not interpreted by the market as a promise, but as a summation of the situation at the time of policy formulation. So the markets should not be surprised if the fed funds rate dips to as low as 1 percent in ‘unusual circumstances.’ But, given the usual circumstances, the communications strategy must ensure that private agents can carry on their businesses as usual, and account for the fact that while expectations are difficult to manage, given that they are not ‘fully rational,’ it ‘is still the right starting point for analyzing the economy and monetary policy.’ 113 Poole’s attempt then is to set out the framework in which the equilibrium between ‘the Federal Reserve’s and the market’s decisions and expectations’ can be established.

RATIONAL EXPECTATIONS EQUILIBRIA

The economic dynamic that Poole wishes to set out relates to the fact that the behavior of the Fed and the market are influenced by their understanding of each other’s expectations of the future: ‘The full rational expectations macroeconomic equilibrium occurs when the market behaves as the Federal Reserve expects and the Federal Reserve behaves as the market expects.’ This is more likely to happen, if at all, when there is a sound communications strategy in place. While there is also the problem of asymmetric information (given that all market participants will not behave in the same way), Poole does not see this as a major problem in Fed communications given that most of the information on which the Fed works is based on reports brought out by ‘government statistical agencies’ and that these reports are ‘the primary source of Federal Reserve information.’ It is also important that the Fed explain clearly the difference between an individual policy action and a policy as such. Miscommunication often arises because of an inability to differentiate between the two in the context of the rational expectations framework.114 While market agents want to be 113 Poole, William (2005). ‘Communicating the Fed’s Policy Stance,’ HM Treasury/GES Conference: Is There a New Consensus in Macroeconomics? London, Nov 30, 2005, available at:http://stlouisfed.org/news/speeches/2005/11_30_05.htm

114 For a full-fledged introduction to the concept of expectations and the role that it plays in not only how the market behaves, but in the formulation of monetary policy,

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able to anticipate the next piece of policy action, the Fed is unable to satisfy them completely in this regard since its next recommendation depends on in-coming economic data. What the Fed can actually do instead is to maintain consistency in terms of the policy without being able to guarantee a specific rate for the federal funds rate in terms of a policy action. In other words, there must be no randomness in the behavior of the Fed since, as Poole points out, ‘in models of macroeconomic policy no one has created a positive case for randomness.’ The stability of monetary policy then depends on building in as much predictability as possible within the context of this framework. At least two interesting examples of this form of predictability are discussed by Poole. The first is the difference between increasing ‘the intended rate of 25 basis points between scheduled meetings has a very different meaning than the same size increase at a scheduled meeting.’ The second pertains to the fact that following the previous Chairman’s decision of August 1989, most policy actions have hovered around 25 basis points. In Poole’s summation: ‘Of the 47 policy actions from 1994 to date, 33 have been 25 basis points changes, 13 have been 50 basis points changes and only one has been a 75 basis points change. There have been no changes larger than 75 basis points.’ Poole’s conclusion then is that this framework will prove itself worthy if the Fed decides to carry forward these elements of regularity, predictability, and stability. These elements will generate a rule-like behavior even if monetary theory has difficulty in supplementing its repertoire of Taylor-like rules, or finds it difficult to follow Taylor’s rule to the letter as has indeed been the case.115

FORMALIZING FED COMMUNICATIONS

While Poole’s framework is not put forth as the official framework of Fed communications (governed as it is by the usual disclaimer about being the work of the author and not necessarily representative of the

see Poole, William (2000). ‘Expectations,’ Twenty-Second Henry Thornton Lecture, Department of Banking and Finance, City University Business School, London, England, Nov 28, available at:

http://www.stls.frb.org/news/speeches/2001/11_28_00.html115 Poole, William (2006). ‘Fed Communications,’ St. Louis Forum, St. Louis, February 24, available at: http://stlouisfed.org/news/speeches/2006/02_24_06.htm

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FOMC); it is important to remember that it has not been refuted by any of the other governors (at least to my knowledge). So while there have been several attempts to formalize a framework of Federal Reserve Communications, the burden of my essay has been to demonstrate that there are indeed strong similarities and continuities in the model put forth by Bernanke, Kohn, and Poole. While a complete model may not be in place (even assuming a linear structure in the accounts provided by the three representatives of the Fed given above); there is little, if any, disagreement or conflict in the FOMC on this matter as evidenced by these frameworks. While all these representatives argue that their attempts at formalization of Federal Reserve Communications is a ‘work in progress,’ and that more work needs to be done in this regard, it is important to remember that these texts represent a beginning rather than an end. There is furthermore the more complex set of questions which have been alluded to in passing in this essay on how communications can help the Fed to further its desire to be more transparent and accountable to the community at large.116 A full-fledged examination of this issue is beyond the scope of this essay, but is worth following up in a separate context, especially since scholars working in this area are still working-through the paradigmatic shift in the change from secrecy to transparency as the necessary precondition to the effective formulation and communication of monetary policy by central banks throughout the world. It will take some more time and theoretical effort before the process and modalities of optimization to further transparency are introduced into this literature.117 In the meantime, scholars of monetary policy are 116 There are a number of internal debates in the central bank literature on the problem of transparency and its relationship to accountability. The primary question in this debate is whether transparency is a means to an end or an end in itself. If it is the former, then the focus should be on whether transparency can help to promote better monetary policy. If it is the latter, then the focus is on the institutional role of the Fed in a democracy. There are arguments in support of both points of view. See Thornton, Daniel L (2002). ‘Monetary Policy Transparency: Transparency about What?’ Working Papers Series, Working Paper 2002-028B, available at:

http://research.stlouisfed.org/wp/2002/2002-028.pdf117 Issing argues that ‘the public’s interest in transparency with regard to monetary policy’s fulfillment of its mandate is essentially in line with the central bank’s interest in using this channel as a means of enhancing monetary policy efficiency.” However this does not mean that central bankers know how to optimize the process of generating transparency since “in an ideal world, the optimum amount of information is determined by the point where the supply and demand curves meet’. But, at our

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forced to battle the anxieties induced by the change in the paradigm, by asking themselves whether they are inadvertently conflating the means-end distinction in promoting transparency as an end in itself while not necessarily addressing all the areas of monetary policy that can benefit from transparency.118

present state of knowledge, ‘the question of where this point is remains difficult to answer in practice’. See Issing, Otmar (2005). ‘Communication, Transparency, Accountability: Monetary Policy in the Twenty-First Century,’ Federal Reserve Bank of St.Louis Review, March/April, 2005, p. 72, available at:

http://research.stlouisfed.org/publications/review/05/03/part 1/Issing.pdf118 Mishkin argues that while there is much more transparency now than before, there is a new danger that that ‘like all virtues it can go too far’. Furthermore, there are areas like ‘output fluctuations,’ which continue to suffer from a lack of transparency and therefore the focus should now be on bringing out the fact that ‘monetary policy will be just as vigilant in preventing inflation from falling too low as it is in preventing it from being too high, and by indicating that expansionary policies will be pursued when output falls very far below potential.’ The Fed, for instance, like other central banks, can demonstrate that it ‘does care about output fluctuations’. See Mishkin, Frederic S. (2004). ‘Can Central Bank Transparency Go Too Far?’ p. 63, available at:

http://www.nber.org/papers/w10829

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PART THREE

CO-CREATING FED COMMUNICATIONS POLICY

The final part of this essay will consider the positions staked out by Ben Bernanke in his most recent talk in November 2013 on ‘Communication in Monetary Policy’ and the positions that his successor Janet Yellen has taken on the same topic. In the Herbert Stein Memorial Lecture that was delivered before the National Economists Club Annual Dinner on November 19, Bernanke made the following points on the role of communication in monetary policy.119

The main contribution of communication he felt was to increase the over-all levels of transparency in monetary policy. In addition, he felt that the Fed’s communication policy was an attempt to ensure that there would be stronger links ‘between monetary policy, financial conditions, and the real economy.’ In addition, the Fed’s communication policy also became important insofar as it had to pull the economy out of a severe recession amidst the financial crisis of 2008. The two important dimensions of Fed policy include the following: the evolution of Fed policy and the effectiveness of Fed policy. Bernanke points out that there is a difference between monetary policy and the expectations that attend to monetary policy actions ‘because those expectations have important effects on current 119 Bernanke, Ben S. (2013). ‘Communication and Monetary Policy,’ Remarks by Ben S. Bernanke, Chairman, Board of Governors, Federal Reserve System, National Economists Club Annual Dinner, The Herbert Stein Memorial Lecture, Washington D.C., November 19, 2013, available at:

www.federalreserve.gov/newsevents/speech/bernanke20131119a.pdf

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financial conditions, which in turn affect output, employment, and inflation.’ The following, needless to say, is the recurrent motif in monetary policy: ‘expectations matter.’

THE DUAL MANDATE

Bernanke goes on to explain why the Fed has not always been able to define a numerical target unlike central banks elsewhere.

The reason is that the Fed has to concentrate on the dual mandate and cannot stop its policy actions with inflation targeting per se. This makes it much more difficult for the Fed since the economy is not responsive only to monetary policy action, but must consider that ‘in contrast to inflation, which is determined by monetary policy in the longer run, the maximum level of employment that can be sustained over the longer run is determined primarily by nonmonetary factors, such as demographics, the mix of workforce skills, labor market institutions, and advances in technology. Moreover, as these factors evolve, the maximum employment level may change over time.’ These are the factors then that make it much more difficult for the Fed to articulate its monetary policy with as much directness as it would like to do. Bernanke knows that employment targets are more likely to be achieved through fiscal policy since ‘it is beyond the power of the central bank to set a longer-run target for employment that is immutable or independent of the underlying structure of the economy.’ Is the Fed then trying to do too much? What is it that the Fed can actually do in matters pertaining to employment numbers? The best that Fed policy should attempt to do is ‘to help eliminate gaps between the current level of employment and its sustainable level – as policy is doing today.’ The FOMC therefore works with a range of 2 percent for

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inflation and 5-6 percent for unemployment numbers. The main achievements so far are that its communication policy has ‘aided the public in forming policy expectations, reduced uncertainty, and made policy more effective.’ These measures however are in the realm of monetary policy as usual albeit with higher levels of transparency.

FED COMMUNICATIONS & THE FINANCIAL CRISIS

The communication measures necessitated by the financial crisis include the following: ‘support the recovery’ and ‘minimize the risk of deflation.’ In order to achieve these monetary policy goals, two important tools were introduced. These tools, as previously mentioned, comprise ‘forward guidance’ and ‘quantitative easing.’ The former helps stakeholders and economic agents to anticipate the path of interest rates and the latter is an attempt to prop up the economy by making ‘large-scale asset purchases’ (LSAPs) which the Fed is now in the process of tapering as the economic recovery gathers momentum. These measures were required because the Fed had exhausted the efficacy of its most important tool: short term interest rates which have already reached the zero-lower bound. The main wager in Fed policy then is that it is possible to make a more effective case for monetary policy accommodation given the difficult circumstances in the economy. This attempt at monetary policy accommodation is expected to last for a number of years until the economy fully recovers. There is however an asymmetric dimension to this problem since if the economy takes too long to recover and the federal funds rate remains at zero, it could pose a serious risk of deflation as turned out to be the case in Japan.

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This is the rationale for Bernanke’s accommodative monetary policy. The task for the Fed is not just to worry about inflation and unemployment: it also has to prevent deflationary spirals that can be as dangerous as hyperinflation.

THE USE OF DATES

An interesting element of innovation in the Fed’s monetary policy is the use of dates since the Fed decided to keep interest rates at zero bound till ‘mid-2013.’ It took a while for stakeholders and economic agents to understand what the Fed was up to since initially forward guidance did not make sense to the uninitiated but eventually everybody understood the significance of dates and the contribution that dates made to the resolution of the ineffectiveness of monetary policy at zero bound. As Bernanke points out, ‘this date-based guidance was more precise than the qualitative language the Committee had been using, and it appears to have been effective in communicating the FOMC’s commitment to a highly accommodative policy. In particular, following the introduction of dates into the FOMC statement, interest rates and survey measures of policy expectations moved in ways broadly consistent with the guidance.’ The dates were in the range of 2012-2013-2015. In addition to this date-based approach, ‘the Committee announced that for the first time that no increase in the federal funds rate target should be anticipated so long as unemployment remained above 6-1/2 percent and inflation expectations remained stable and near target.’

COMMUNICATING LARGE-SCALE ASSET PURCHASES

The bulk of Fed communications also related to ‘large-scale asset purchases.’ It would not be unfair to say that Bernanke’s main goal was to make an effective case for doing things that had not been done before since he and the FOMC were venturing beyond the safe confines of merely moving the federal funds rate up and down. The notion that the Fed had become ‘activist’ in its orientation to monetary policy is mainly related to large-scale asset purchases. This was the most controversial of all measures since many felt that it was artificially propping up the economy, and that the firms which benefited from these measures would not be able to survive the process of tapering. While it remains to be seen what the full-extent of the Fed’s taper will

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be in the broader economy, it is not difficult to understand that this should take the better part of Bernanke’s attention as the Fed chair or take pride of place – for better or worse – in the Fed’s communication policy. These measures were related to Section 13(3) of the Federal Reserve Act of 1913: most stakeholders did not even know such provisions existed in the FRA let alone expect the Fed to use them.

THE FED’S BALANCE SHEET

Another important topic was the Fed’s balance sheet and specifying what amounts were invested in large-scale asset purchases in the form of mortgage-backed securities. Bernanke provides a brief cost-benefit analysis of large-scale asset purchases program and points out that ‘a complete accounting of the fiscal effects of LSAPs should take into account the beneficial effects of a stronger economy on tax receipts, interest payments, and government spending; the reduction in the budget deficit from these sources will certainly outweigh the effects of the deficit of any changes in the pace of Fed payments.’ In addition to these benefits, Bernanke also calls attention to the fact that ‘while fiscal effects are important, the full effect of the FOMC’s policies also includes important additional benefits of increased economic growth and employment and of greater price stability.’ It would, needless to say, have been very difficult for Bernanke to envisage that what started off as an attempt to bring greater transparency in FOMC deliberations when he became Chairman would wind up as a full-fledged attempt to not only innovate but introduce, deploy, and assess the efficacy of a range of new monetary policy tools. Bernanke anticipates that the Fed would indeed continue with its accommodative approach to monetary policy in the near future and that ‘communication about policy is likely to remain a central element of the Federal Reserve’s efforts to achieve its policy goals.’ What has characterized Bernanke’s stint as Chairman then is the interdependence between the Fed’s need to communicate its monetary policy objectives even while it was attempting to formalize its communication policy.

JANET YELLEN ON FED COMMUNICATIONS

The first thing that Fed-watchers will notice about Janet Yellen is that even in her initial remarks during her ceremonial swearing-in, she

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began by emphasizing the importance of the Fed’s communication policy. She pointed out, for instance, that one of Bernanke’s most important achievements was to initiate ‘press conferences in 2011.’ This is an important positioning statement on her part since Yellen believes that ‘communication is vital in a democracy and especially important for the Federal Reserve which relies on the confidence of the public to be effective in carrying out its mission.’ It is interesting that Yellen address the Fed’s communication policy even before she goes on to address more vexing problems like Dodd-Frank, financial regulation, the need to repair the financial system, and unemployment. It is easy to overlook the importance that Yellen attributes to the Fed’s communication policy and the Fed’s staff. There is in fact an important connection between these points since the contributions made by the Fed’s staff can be lost in the absence of an effective communication policy.

As Yellen points out, the Fed’s staff ‘work tirelessly, day in and day out, to serve the public interest. Their skill, creativity and perseverance enabled the Fed to do its part to meet the grave threats our nation faced in the financial crisis and then persevere in a disappointingly slow recovery.’120 In order to understand what Yellen means by the role of communication in monetary policy however we must turn to three important statements that she made on this topic in 2006, 2012, and 2013. I will set out the main positions that Yellen took in these

120 Yellen, Janet L. (2014). ‘Remarks’ by Janet L. Yellen, Chair, Board of Governors, Federal Reserve System, at the Ceremonial Swearing-In Atrium, Federal Reserve Board, Washington D.C., March 5, 2014, available at:

http://www.federalreserve.gov/newsevents/speech/yellen20140305a.pdf

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speeches and then demonstrate how her positions are related to those of her predecessor, Ben Bernanke.

YELLEN AT THE WASHINGTON POLICY CONFERENCE

Yellen begins by asking how effective Fed communications can enhance the Fed’s credibility in terms of its monetary policy stance. She makes this connection as early as 2006 in a speech to the Annual Washington Policy Conference when she was President and CEO of the Federal Reserve Bank of San Francisco.121 The main goal of this stability is to maintain ‘price stability’ (i.e. low levels of inflation). The main anxiety on this score is that if the Fed loses its credibility in matters pertaining to price stability, it will lead to a situation where inflationary expectations will become increasingly difficult to manage effectively. The Fed’s inflation policy therefore depends on whether or not economic agents believe the Fed’s commitment in matters pertaining to price stability (this includes preventing both inflation and deflation from negatively affecting the broader economy). Credibility increases the probability that the Fed and the public will work together and not at cross purposes with each other.122 This argument is similar to what Bernanke means by a convergence of expectations between the Fed and the broader economy within the model of rational expectations.

121 Yellen, Janet L. (2006). ‘Enhancing Fed Credibility,’ Luncheon Keynote Speech to the Annual Washington Policy Conference, Sponsored by the national Association for Business Economics, March 13, 2006, available at:

http://www.frbsf.org/our-district/press/presidents-speeches/yellenspeeches/2006/march/enhancing-fed-credibility/060313.pdf122 Taylor points out for instance that ‘according to rational-expectations models, there are advantages to credibility in both monetary policy and fiscal policy. For example, a disinflation will have lower short-run costs if policy is credible. Similarly, a plan to reduce the budget deficit will have a smaller short-run contractionary effect if it is credible.’ See Taylor, John B. (1997). ‘A Core of Practical Macroeconomics,’ AEA Papers and Proceedings, May 1997, 87:2, p. 234.

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It is important for Yellen too that the public at large are able to not only anticipate but work in tandem with the Fed in defining the range of expectations within a model of rational expectations. The advantage of doing so is that it will increase the level of alignment between the Fed and the public. ‘This alignment of the Fed’s actions and public’s expectations strengthens the monetary policy transmission mechanism and shortens policy lags. In contrast, in the absence of credibility, policymakers and the public may work at cross-purposes, and monetary policy must act to overcome and dislodge expectations that hinder the achievement of our goals.’ This was the reason that the US economy experienced a severe stagflation prompting Paul Volcker to start his protracted attempts to reduce inflation even while the economy plunged into a deep recession. Yellen believes that research on the role played by Fed communications will help to align the Fed with the public and reduce inflationary expectations provided the Fed does what it can to enhance its credibility. Yellen’s interest in Fed communications, in a sense, is a result of the need to avoid repeating the mistakes of the past when the Fed was not seen as sufficiently committed to price stability. A more difficult question that follows from this argument is whether Fed numerical targets should be made explicit or whether it is better to invoke a suitable range within for attaining its policy objectives. Yellen argues that an explicit number ‘could shift inward the “macroeconomic possibilities frontier” – the

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economy’s menu of feasible output and inflation volatility combinations.’

INFLATIONARY & DEFLATIONARY EXPECTATIONS

So price stability involves managing both inflationary expectations and deflationary expectations: both can lead to instability in the broader economy. As Yellen points out, ‘the most unsettling aspect of the experience of Japan over the past decade is how difficult it can be to extract oneself from deflation. An explicit numerical long-run inflation objective may help anchor inflation expectations as a low positive number and avoid a potentially devastating inflationary spiral.’

Though numerical definitions of price stability have not been of help in countries like Canada and Sweden, Yellen believes that too much credibility is better than too little credibility and that ‘an inflation rate of 1-1/2 percent as measured by the core personal consumption expenditures price index, with a comfort zone extending between 1 and 2 percent, as an appropriate price stability objective for the Fed.’ In the context of the dual mandate, Yellen points out that the Humphrey Hawkins Act already stipulates ‘a 4 percent unemployment rate target’; this is something that the Fed cannot do since an ‘explicit numerical long-run unemployment objective would be misguided and confusing, and could endanger’ the Fed’s ‘hard-won credibility.’ So, to summarize Yellen’s position in 2006, the goal of Fed communications is to increase transparency and accountability in the first instance: it is these that will result in an increase in the Fed’s credibility. Enhanced Fed credibility will make it easier to align the Fed with the public at large, and manage both inflation and deflation in the context of price stability; and that in turn, will ensure the stability of the economy in terms of both ‘employment and output.’

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YELLEN AT THE MONETARY POLICY FORUM

Yellen’s next foray at explaining the importance of Fed communications as Vice Chair was at the US Monetary Policy Forum in New York in 2011.123 Yellen’s intent in this forum was not merely to present information about the economy, but to discuss the efficacy of unconventional monetary policy tools ‘and the transmission mechanisms through which they influence the economy.’ Yellen also invokes simulations (using the FRB/US macroeconomic model of the US economy) to analyze whether the economy would be doing better if the Fed had done nothing in a counter-factual scenario. The main point that she makes about the transmission mechanism is that it is important to remember that both ‘current short term rates’ and ‘the anticipated path of short term rates’ are relevant in determining long-term rates. It is therefore important to think in terms of an ‘expectations channel’: the effectiveness of this channel depends on how well economic agents relate the ‘economic conditions’ to ‘monetary policy,’ and the level of responsiveness that they would attribute to the Fed. It is however important to identify the transmission channels of monetary policy for both short and long-term securities and compare those of conventional with those of unconventional monetary policy.124

TRANSMISSION MECHANISMS

Yellen argues that these mechanisms are ‘similar’ but not ‘identical,’ and it is difficult to avoid a spill-over effect in the financial markets, stock-exchanges, and the foreign exchanges markets. These effects however had to be tolerated since the Fed had gone as far as it could using conventional policy tools when interest rates hit zero and the Fed 123 Yellen, Janet L. (2011). ‘Unconventional Monetary Policy and Central Bank Communications,’ Remarks by Janet L. Yellen, Vice Chair, Board of Governors, Federal Reserve System, at the US Monetary Policy Forum, New York, New York, February 25, 2011, available at:

www.federalreserve.gov/newsevents/speech/yellen20110225a.pdf124 For a definition of transmission mechanisms in monetary policy, see Hafer, R.W. (2005). ‘Policy Transmission Mechanism,’ The Federal Reserve System: An Encyclopedia (Westport and London: Greenwood Press), pp. 302-303.

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was forced to consider the scope of forward guidance and large-scale asset purchases. It is important to keep in mind that the ‘Committee’s forward guidance has been framed not as an unconditional commitment to a specific federal funds rate path, but as an expectation that is explicitly contingent on economic conditions.’ The next challenge for the Fed’s communication policy will arise when it is necessary to taper asset purchases and move back to a more normal monetary policy, but the burden of her speech was to make an effective case for the fact that counter-factual simulations led the FOMC to believe that it did the right thing by embarking on unconventional monetary policy.

YELLEN AT HASS, UC-BERKELEY

Yellen returned to some of these themes in 2012 at the Hass Business School at UC-Berkeley.125 In her remarks on this occasion, Yellen points out that what started off as experiments in central bank communications has now become a full-fledged revolution that has spread through-out the world. It would not be an exaggeration to say that there is now already an emerging literature on this area and that both Fed staffers and academics have taken to the study of Fed communications from both a theoretical (i.e. what is) and a practical (i.e. how to) point of view.

125 See Yellen, Janet L. (2012). ‘Revolution and Evolution in Central Bank Communication,’ Remarks by Janet L. Yellen, Vice-Chair, Board of Governors, Federal Reserve System, Hass Business School, University of California, Berkeley, November 13, 2012, available at:

www.federalreserve.gov/newsevents/speech/yellen20121113a.pdf

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Here again, we will find a number of important similarities between her positions and those of Ben Bernanke. Both of them for instance are in strong agreement that one of the main goals of contemporary Fed communications policy is to make an effective case for two important measures that the Fed announced under their leadership: forward guidance on the path of interest rates and quantitative easing through large-scale asset purchases in mortgage-backed securities, debt securities, and treasury securities. Fed communications provides both a rationale and a justification for these purchases along with an analysis of its implications for the Fed’s balance sheet.126 One of the important points in contention is that these purchases will not lead to losses for the Fed, but will help to stabilize the economy, as the Fed tapers gradually. Transparency on these matters will not only increase the credibility of the Fed as a system that knows what it is doing, but also set in place a model of rational expectations.

126 This topic is also addressed by Powell: his main contention however is ‘that what matters is the overall stance of policy, not the pace of asset purchases.’ See ‘Communication Challenges and Quantitative Easing,’ Remarks by Jerome H. Powell, Member, Board of Governors, Federal Reserve System, at the 2013 Institute of International Finance Annual Membership Meeting, Washington D.C., October 11, 2013, available at:

www.federalreserve.gov/newsevents/speech/powell20131011a.pdf

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YELLEN ON BOB LUCAS

Yellen explicitly invokes the work of Robert Lucas as the economist whose work did more than anybody else to provide the theoretical grounds for Fed communications.127 As Yellen points out, ‘Robert Lucas mainly analyzed models in which only monetary surprises have any effect on real activity, his important insight in the present context was that the perceived monetary policy rule is critical in determining the effects of monetary policy actions, both anticipated and unanticipated.’ The main takeaway then from the model of rational expectations is that it is not the federal funds rate at any a particular point in time in itself, but rather the projected path of interest rates that will affect how a range of variables like ‘longer-term interest rates,’ ‘asset prices,’ ‘income,’ ‘inflation,’ play out in the broader economy. A test case in contention is how the Fed responds to inflationary pressures created by oil shocks and whether or not the public at large expects that the Fed will ‘allow an oil price shock to precipitate a general rise in inflation.’ If the Fed’s credibility is high, the public is likely to expect the Fed to allow such a precipitation in levels of inflation. This is also why the Fed prefers to have a 2 percent inflation target – anything less than that will give the Fed less room to maneuver in case it becomes necessary to accommodate an increase in oil prices. Needless to say, any attempt at forward guidance or enhanced forward guidance will 127 A good introduction to how the economist Robert Lucas brought the model of rational expectations into macroeconomics and its implications for monetary policy is available in Chari, V. V. (1998). ‘Nobel Laureate Robert E. Lucas, Jr.: Architect of Modern Macroeconomics,’ The Journal of Economic Perspectives, 12:1, Winter 1998, pp. 171-186. For a technical discussion on the econometric implications of macroeconomic models using the rational expectations paradigm, see Evans, George W. and Honkapohja, Seppo (2005). ‘An Interview with Thomas J. Sargent,’ CESifo Working Papers, No 1434, Ifo Institute – Leibniz Institute for Economic Research at the University of Munich, available at: http://hdl.handle.net/10419/18798

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also require that the public understand what the Fed is trying to do by providing such guidance in the first place. That is why the Fed has also tried to explain what sort of an ‘exit strategy’ will mediate its tapering of large-scale asset purchases.

OPTIMAL POLICY PATH

Yellen concludes her Hass address by explaining the challenges of discovering an ‘optimal policy path’ for the federal funds rate and how exactly the Fed goes about trying to communicate this path to stakeholders. The macroeconomic model that the Fed uses for delineating this policy path is based on the FRB/US model since this ‘model lets us analyze every possible policy path to see which one yields the best feasible outcome for the paths of employment and inflation.’ This policy path must accommodate both inflation and unemployment targets of 2 and 6 percent respectively including deviations, if any. It accords equal weight to both objectives in the context of the dual mandate.

Yellen points out that the public can expect the Fed to commit to the calculation of an optimal path within a model of rational expectations. Given the current economic scenario, the Fed’s zero bound policy for the federal funds rate is expected to last up to 2016 given the unemployment numbers even if there is a risk that inflation may slightly exceed the 2 percent target. There is an important difference however between discovering and communicating an optimal policy path. An important tool that can help the Fed to think-through this path is the Taylor rule which ‘fits the behavior of the Fed reasonably well from the late 1980s until the financial crisis.’ However during a crisis when levels of deviation are much more, it can be difficult to optimize the policy path without modifying the rule. Even the modified rule, Yellen argues, may not be optimal enough since it ‘would raise the

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federal funds rate substantially earlier than the optimal path and thereby leads to more protracted deviations of the unemployment rate above its longer-run normal level without any measurable gains in keeping inflation closer to the 2 percent target.’

COMMUNICATING THE OPTIMAL POLICY PATH

That is why it is difficult to communicate the optimal policy path: it would be a lot easier to communicate the path if it always approximated to or was the same as the path prescribed by the rule accounting without exception for any significant deviations that must be incorporated into the requisite calculations for determining the policy path. Yellen’s conclusion then is that simple monetary policy rules may not be adequate to predict the path of the federal funds rate. Additional communication tools that the Fed could deploy include the publication of forecasts and a summary of economic projections for variables like ‘the unemployment rate, real GDP growth, and inflation,’ and ‘guidance on economic conditions’ that would justify an increase in the federal funds rate in the future. Yellen also emphasizes the importance of the thresholds doctrine for the rate of inflation and unemployment since these ‘would serve as a kind of automatic stabilizer for the economy.’ It will also help the FOMC to make up its mind on how ‘to justify a decision to stop, or scale back, its asset purchases.’ Yellen’s conclusion is that the more unconventional monetary policy becomes, the greater is the need for an effective Fed communication policy. But the communication policy - like the innovation of unconventional monetary policy tools – is a work-in-progress and in Yellen’s assessment while ‘we’ve made progress…much work remains to be done.’

AT THE SOCIETY OF AMERICAL BUSINESS EDITORS & WRITERS

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The fourth and final speech of Yellen’s that I will consider in the attempt to situate her policy positions in matters pertaining to Fed communications was delivered when she was Vice-Chair before the Society of American Business Editors and Writers on April 4, 2013.128

Yellen’s task in this address is ‘to show how communication plays a distinct and special role in monetary policymaking.’ Her forum is well-chosen since business editors are mainly in the business of communication both as producers and as consumers. Yellen’s message to this forum is simple: ‘monetary policy is primarily concerned with affecting expectations of the future.’ The question that she addresses in the context of expectations is the sense of incredulity that her students experienced when she used to teach economics. The sense of incredulity related to the following question: ‘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 ¼ of a percentage point?’ The whole point of Fed communications relates precisely to the fact that – as previously discussed – expectations are not related to a particular instance of raising or lowering of interest rates, but rather to the policy path as an instantiation or symbolic representation of rational expectations.129 So the answer to the question is: ‘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.’ The main goal of Fed communication then is to provide forward guidance to various degrees so that there is policy certainty ‘for a considerable period.’ This form of forward guidance came into public consciousness when the FOMC informed the public that in addition to reducing the federal funds rate to 1 percent, it is willing to maintain an 128 Yellen, Janet L. (2013). ‘Communication in Monetary Policy,’ Remarks by Janet L. Yellen, Vice-Chair, Board of Governors, Federal Reserve System, at the Society of American Business Editors and Writers, 50th Anniversary Conference, Washington D.C., April 4, 2013, available at:

www.federalreserve.gov/newsevents/speech/yellen20130404a.htm129 See, for instance, Taylor who points out that ‘when economists evaluate monetary policy, they simulate models with policy rules inserted in them rather than simply simulating one-time changes in the instruments. When financial market analysts try to determine what a central bank should or should not do, they usually consider a monetary policy rule. And central banks frequently use policy rules as an input to their actual decisions.’ See Taylor, John B. (2002). ‘A Half-Century of Changes in Monetary Policy,’ Written Version of Remarks Delivered at the Conference in Honor of Milton Friedman, University of Chicago, November 8, 2002.

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accommodative monetary policy going forward. Yellen is keen that everybody learns to appreciate what the FOMC was doing at this particular moment; as she points out, ‘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, however, communication was an independent and effective monetary policy tool for influencing the economy, providing forward guidance, and shaping rational expectations in the broader economy.

CONCLUSION

The Federal Open Market Committee had journeyed a long way indeed from Montague Norman’s motto of ‘never explain’ what the Fed is trying to do, ‘to a point where sometimes the explanation is the policy’: that is, there is a performative element to the articulation of the policy where ‘form’ and ‘content’ are difficult to differentiate.130 The difference however between what the Fed was doing in this instance as opposed to what it used to do in the past was to actually explain its actions in a language that was comprehensible. In the past it had counted on ‘its record of systematic behavior.’ So while it may not have tried to explain its actions, it would try to behave in a way that was ‘predictable.’131 Those arrangement were however to come under enormous strain after the financial crisis of 2008 when the main focus turned to explaining the role that would be played by unconventional monetary policy tools including large-scale asset purchases and the fact that forward guidance now comprises not only the projected path of the federal funds rate but also guidance on how much the Fed will buy, hold, and sell of a range of securities. The next challenge for the Fed’s communication policy will relate to the process of tapering asset purchases in the months ahead. This process is commonly misunderstood: Yellen therefore explains that ‘the Federal Reserve’s ongoing asset purchases continually add to the accommodation that

130 Holmes, Douglas R. (2014). Economy of Words: Communicative Imperative in Central Banks (Chicago: University of Chicago Press), passim.

131 For an introduction to the challenges of systematic behavior in Fed policy making, see Hetzel, Robert L. (2006). ‘Making the Systematic Part of Monetary Policy Transparent,’ Federal Reserve Bank of Richmond, Economic Quarterly, 92/3, Summer 2006, pp. 255-289.

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the Federal Reserve is providing to help strengthen the economy… an end to those purchases means that the FOMC has ceased augmenting that support, no that it is withdrawing accommodation.’ That is why clarity is explaining policy prescriptions are important since a great deal of the anxiety relating to tapering is based on making precisely this conflation. Large-scale asset purchases is an important element of monetary policy accommodation, but it not the same as monetary policy accommodation.

And so, as Yellen points out, ‘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.’ The normalization of the Fed’s balance sheet will also be done in a way that will ‘minimize the risk of market disruption’, and the public will have a better understanding of the revised structure of the Fed’s portfolio going forward. What Fed communication will also prepare the broader economy for is the point when it will become necessary to increase the federal funds rate over the period between the years 2015-2016. While the return to economic normality might give the Fed less to explain, Yellen does not envisage a situation in the immediate future where irrespective of the state of the economy Fed communications will cease to matter. She concludes by saying that ‘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.’

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SHIVA KUMAR SRINIVASAN

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