speeches · February 23, 2000

Speech

William Poole · President

Great Monetary Myths GreatIssuesSeries SaintLouisUniversity St.Louis,Missouri February24,2000 Why “Great Monetary Myths”? MYTH ONE: Whynot“GreatMonetaryTruths”? TIGHT MONETARY POLICY Iwillcertainlybediscussing INCREASES UNEMPLOYMENT some great truths in the process of discussing great myths. My motivation, ThefinancialpresslikestorefertoFedoffi- though, is this: In any important area of public cialsaseither“inflationhawks”or“inflation policy, mistakesareoftendrivenbypublicmis- doves.”Thehawksareassumedtobeinsensitive understanding of the issues. We live in a vigor- tounemploymentissues,whereasthedovesshow ous democracy, andattheendoftheday,at truecompassionfortheunemployedorpoten- leastinthelongrun, the Federal Reserve will tiallyunemployed. pursue policies the voters want. As most of you Asaninflationhawkwhobelievesfirmlythat know, the U.S. President appoints, and the sustainedlowinflationisemployment-friendly, Senate confirms, membersoftheBoardof Ifindthismythparticularlytroublesome.Ithink GovernorsoftheFederal Reserve System. The themythhastwoorigins.First,economistA.W. U.S. Congress can amend theFederalReserve Phillips,writinginthelate1950s,proposedthat Actatanytime.Ifthepublic “knows” things thereisatradeoffbetweenunemploymentand that aren’t true, this misinformation will ulti- inflation.Second,therehavecertainlybeen mately work its way through our democratic periodsinthepastinwhichFederalReserve government and damage monetary policy. policymistakescausedincreasesinunemploy- Beforeproceeding,Iwanttoemphasizethat ment,atleastforatime.Letmeaddressbothof theviewsIexpressherearemineanddonot theseissues. necessarilyreflectofficialpositionsoftheFederal Phillips’worksparkedanenormousacademic ReserveSystem.Ithankmycolleaguesatthe literature.BasedonhisanalysisofU.K.data, FederalReserveBankofSt.Louisfortheircom- Phillipsclaimedthatunemploymentwasconsis- ments,butretainfullresponsibilityforerrors. tentlyhigherwheninflationwaslower,andunem- Iwilldiscussfourimportantmonetary ploymentlowerwheninflationwashigher.This myths.Theseare,first,thattightmonetarypolicy relationshipbecameknownasthePhillipscurve. increasesunemployment.Second,thattight AfewyearsafterthePhillipspaperappeared,U.S. monetarypolicyraisesinterestrates.Third,that economistsarguedthesameaboutU.S.data. higherinterestratesdepresstheeconomy.And Inthemid-1960s,MiltonFriedmanand fourth,thatmonetarypolicydecisions—the EdmundS.Phelpsindependentlypublished FederalReserve’sactionsmeetingbymeeting— papersdisputingtheexistenceofaPhillipscurve arefundamentallypolitical.Indiscussingthese tradeoffbetweenunemploymentandinflation. myths,I’llrelyoneconomicinformationthatI Thegistoftheircritiqueswasthattheapparent hopeconvincesyouthattheseclaimsare,infact, empiricalregularitywasashort-runphenomenon, mistaken. notonethatcouldcontinueoverthelonghaul. 1 MONETARYPOLICYANDINFLATION Subsequentworkandactualexperience Ashigherinflationcontinued,peoplebecame aroundtheworldconfirmedthevalidityofthe accustomedtothenewenvironment.Andas Friedman-Phelpsview.ThePhillipscurvetrade- peopleadjustedtohigherinflation,theynolonger offwasatmostashort-runphenomenon.Some madethedecisionstheymadeinthelate1960s ofthemonetarypolicymistakesofthe1970s,how- wheninflationwasnewandsurprising.The ever,wereadirectconsequenceoftheearlier unemploymentraterosebacktothelevelsseen acceptanceofthePhillipstradeoffview.Butover earlier,andindeedrosesignificantlyhigherdur- thecourseofthe1970s,welearnedthatpolicies ingseveralsevererecessions. consistentwithsustainedhigherinflationdidnot Althoughtheeconomydoesseemtowork producesustainedlowerunemployment. betterandmoreefficientlywhentherateofinfla- Let’slookatthecommonsenseandfunda- tionisinthe2to3percentrangethanwhenitis mentaleconomicsaspectsofthePhillipscurve inthe8to10percentrange,themostimportant issue.SupposeyoutraveltoEuropeandseeinthe pointisthat,asafirstapproximation,theunem- newspaperthattheweatherwillbesunnywith ploymentrateislittleaffectedontheaverage. temperaturesaround18˚Celsius.Doyoutakea Peopledolearnhowtofunctionprettywelleven coatwhenyouleaveyourhotelroom?Ifyouare whentheyhavetousearubbermonetaryyard- notfamiliarwiththeCelsiusscale,itiseasyto stick—ayardstickforwhichthepurchasingpower makeamistake.Butafteryouhavegoneoutside ofadollargetssmallerandsmalleryearafteryear. afewtimes,youwillunderstandthat18˚Celsius Peopleadjustedprettywelltoaworldinwhich isprettycloseto65˚Fahrenheit.Yourdecisionto wagesandpriceswererisingat8or10percent wearacoatwillhavenothingtodowithwhether peryear;mostlearnednottomakemistakesfrom yourthermometerreads65˚Fahrenheitor18˚ assumingthattheaveragelevelofpriceswaslikely Celsius. toremainroughlyunchanged,wheninfactprices Bythesametoken,yourbehaviorinthelabor wererisingsignificantly. marketmaywellbeaffectedastheinflationary So,itissimplyamyththattheFederalReserve environmentchanges.Ifyouareaccustomedto canfollowaneasymonetarypolicythatleadsto livingwithlowinflation,aspeoplewerein1965, higherongoinginflationwiththebenefitofsus- youmayfindyourdecisionsaffectedbyhigher tainedlowerunemployment.Theargumentthat inflationthatisratherasurprise.Someofthese thelong-runPhillipscurveisapproximatelyver- decisionsmaystemfromyourexpectationsthat tical—thatthereisnosustainedtradeoffbetween theinflationwillbetemporary.Suchexpectations unemploymentandinflation—isacceptedbyall arenaturaliftheeconomyhasenjoyedasubstan- mainstreameconomists,whatevertheirpolitical tialperiodoflowinflation. persuasion.Thereareimportantandinteresting Theunemploymentratedidfallsignificantlyin professionaldisputesaboutwhetherashort-run thelate1960sastherateofinflationrose.Workers tradeoffexistsand,ifso,howlongittakesfor respondedtohighermoneywagesbyaccepting theeconomytoundergothetransitionfromthe jobsmorereadily,therebydecreasingunemploy- shortruntothelongrun.Butintheeconomics ment,onlytodiscoverthathigherinflationwas profession,thelong-runissuehasbeensettled erodingthepurchasingpowerofthehighermoney for25years. wages.Real,orinflation-adjusted,wagesjust U.S.experienceinrecentyearscertainlyrein- weren’tashighasworkershadexpected.Similarly, forcesthelessonthatthereisnoinconsistency firmsincreasedproductioninresponsetohigher betweensustainedlowinflationandsustained prices,onlytofindthatprofitswereelusiveas lowunemployment.Lastyear,theunemployment productioncostsrosemorethananticipated. rateaveraged4.2percent;theratehadbeen5.6 Bothworkersandfirmsmisreadthewageand percentin1995.Basedontheannualaverageof pricesignals,justasAmericantouriststraveling theconsumerpriceindex,theinflationratewas abroadmightmisreadthethermometer. 2.2percentlastyear;theratehadbeen2.8percent 2 GreatMonetaryMyths in1995.Ithinkthereisastrongcasethatsustained forceswillpushintheotherdirectionandinterest lowinflationcontributestoasomewhatlower rateswillbesomewhatlower.Onaverage,over unemploymentrateontheaverage;A.W.Phillips time,ifinflationremainslowandsteady,interest wassimplywrong.AndIthinkthereisan rateswillfluctuatearoundalevelthatisdeter- absolutelycompellingcasethatsustainedlow minedbynon-monetaryforcesintheeconomy. inflationreducestheinstabilityoftheeconomy. WhentheFedconductspolicytosustainlow Thebottomline?Sustainedlowinflation, inflationbychangingtheintendedfedfundsrate, achievedthroughdisciplinedandpredictable whatitistryingtodoistomoreorlessmimic tightmonetarypolicy,isemployment-friendly. howthesemarketforceswouldcauseinterest ratestofluctuate. SupposethattheFedresistsmarketforces MYTH TWO: thatarepushingupinterestratesatsomepartic- TIGHT MONETARY POLICY ulartime.TheresultisthattheFedcreatesan excessiveamountofliquidityintheeconomy, RAISES INTEREST RATES unleashinginflationaryforces.Asinflationrises, TheFederalReserveconductsmonetarypolicy lendersdemandaninflationpremiuminthe intheshortrunbysettingatargetforthefederal interestratestheycharge,andborrowersare fundsinterestrate—theratebankschargeone willingtopaythatpremium.Wheredoesthe anotherontheirloansofreservesondepositat inflationpremiumcomefrom?Supposeyouare FederalReserveBanks.TheFedcallsitstarget debatingwhethertospend$1,000ontheecono- the“intendedfederalfundsrate.” mist’sfavoriteobject—thewidget.Youareconsid- Incommonlanguage,whentheFedincreases eringwaitingayearandinvestingthefundsina theintendedfederalfundsrate,peoplesaythat savingsdepositearning4percent.Theinflation monetarypolicyistighter.Inthissense,theclaim rateis2percent,andlet’sassumethatthepriceof thattightmonetarypolicyraisesinterestratesis thewidgetswillincreasealongwiththegeneral truebydefinition.Theinterestingissue,though, levelofprices.Yourchoicetheniswhethertobuy iswhetheraFedpolicythatissuccessfulinkeep- now,spending$1,000,ornextyear,spendingan inginflationlowhastheeffectofraisinginterest expected$1,020.Ifyouspendnextyear,youwill rates.Ajumptothewrongconclusionispretty takethefundsoutofyoursavingsaccount;at4 easy.TheFedraisestheintendedfedfundsrate percentinterest,the$1,000willhavebecome tokeepinflationundercontrol.Therefore,it $1,040.Inthisexample,thereal,orinflation- seems,apolicytokeepinflationundercontrol adjusted,rateofinterestis2percent—nominal leadstohigherinterestrates.Theproblemisto interestof4percentlessinflationof2percent. sortoutshort-runfluctuationsfromlonger-run Nowsupposeyouexpect6percentinflation fundamentals. insteadof2percent.Youexpectthatinayear, Thewaytounderstandthisfallacyistosup- thewidgetwillcost$1,060.Ifinterestonyour posethattheFedhadsomeotherpolicyinstru- ment,notinvolvingdirectcontrolofinterestrates, savingsaccountremainsat4percent,youwill tomaintainlowandsteadyinflation.Withsus- certainlywanttobuynowinsteadofwaitinga tainedlowinflation,marketforceswillsometimes year.At4percentinterest,lotsofpeoplewillbe pushinterestratesupandsometimesdown.For spendinginsteadofsaving,becausetherealrate example,wheneconomicconditionsareparticu- ofinterestisnownegative—4percentinterest larlystrong,peoplewillwanttoborrowfundsto less6percentinflation,orminus2percent.The supportnewbusinessinvestment,newhousehold reducedsupplyofsavingwillforceupnominal purchasesofcarsandhouses,andsoforth.In interestrates.Whennominalratesreach8percent, timeslikethese,interestrateswillbeonthehigh therealratewillagainbe2percent—8percent side.Whentheeconomyweakensabit,those interestless6percentinflation. 3 MONETARYPOLICYANDINFLATION IfinflationgetsawayfromtheFed,asitdid alonganunchangeddemandcurveorbecause startingin1965,nominalinterestrateswillrise— thedemandcurvehasshiftedout,slidingalong perhapssooner,perhapslater—toreflectinflation anunchangedsupplycurve.Inoneinstance,price expectations.Thehomemortgagerate,forexam- ishigherandquantityislower;inthesecond ple,wentfrom5.81percentin1965to14.70per- instance,priceishigherandquantityisalso centin1981.IfFedpolicyistokeepinflationlow, higher. theFedwillhavetopermitratestoriseorfall Let’susethissimplemodeltobetterunder- fromtimetotime.However,ontheaverage, standtherelationshipbetweeninterestratesand interestrateswillbesubstantiallylowerina economicactivity.Toconcentrateonthepolicy periodoflowandstableinflationthanduringa effectsoneconomicactivity,let’sassumethatFed periodofhighinflation. policyissuccessfulinkeepinginflationlow.On Thebottomline?AFedpolicythatresists theverticalaxiswe’llmeasuretheinterestrate, marketpressuresbyholdinginterestratesdown whichisatypeofprice,andonthehorizontal canbesuccessfulforafewmonthsorevenafew axiswe’llmeasuregrossdomesticproduct(GDP). quartersatatime,buteventuallybothinflation Thereisacomplicatedsortofdemandcurve andinterestrateswillenduphigherthanthey relatingtheinterestratetoGDP—thisdemand wouldhavehadtheFedactedearlytoprevent curveslopesdown.Thatis,alongthiscurve,lower inflationfrombecomingembeddedintheecon- interestratesareassociatedwithhigherGDP. omy.Thus,atightmonetarypolicythatissuc- Thereisalsoanupward-slopingsupplycurve cessfulinkeepinginflationlowandstablewill thatisinfluencedbyFederalReservepolicy keepinterestratesonaveragelowerthanthey actions.Ifmarketforcesshiftthedemandcurve wouldbeunderapolicythatpermitshigher out,theresultwillbehigherinterestratesand inflation. higherGDP.Ifthesupplycurve,influencedby Fedpolicyactions,shiftsback,theresultwillbe higherinterestratesandlowerGDP.Thus,atthe equilibriumofthesetwocurves,ahigherinterest MYTH THREE: ratemaybeassociatedwithlowerGDP,butnot HIGHER INTEREST RATES WILL necessarily.Similarly,alowerinterestratemaybe DEPRESS THE ECONOMY associatedwithhigherGDP,butnotnecessarily. Theclaimthathigherinterestrateswill TheFed’sjobistotrytoadjustmonetary depresstheeconomyisamyth.Sotooisthe policysothatthesupplyofgoodsandservicesis claimthatlowerinterestrateswillstimulatethe matchedbythedemandforgoodsandservices economy.Thesemythsreflectconfusionover atalowandstableinflationrate.IftheFeddoes whether,inanyparticularcircumstance,rates itsjobcorrectly,interestrateswillriseaseconomic arebeingdrivenupordownbysupplyordemand fundamentalsdrivethemhigher,butinflation conditions. willremainsubdued.And,whenrequiredby Let’sstartbyemphasizingsimplefundamen- economicfundamentals,theFedwillpushinter- tals.Takeoutascrapofpaper,orjustuseyour estratesdownsothattheequilibriumofsupply imagination.Drawasupplyanddemanddiagram anddemandforgoodsinthemacroeconomy withpriceontheverticalaxisandquantityon occurswithnosustainedchangeintherateof thehorizontalaxis.Thesupplycurveslopesup inflation. andthedemandcurveslopesdown.Theinter- AnyonewithanInternetconnectioncan sectionofthetwodefinestheequilibriumprice observeinterestratesminutebyminute,butthere andquantityinthemarketplace.Whatcanwe isnowaytoobserveeconomicactivityminuteby concludeaboutquantityfromtheknowledgethat minute.Whenweobserveinterestrateschanging, priceishigher?Nothing.Pricecanbehighereither wecanonlyguessatwhatisgoingonwiththe becausethesupplycurvehasshiftedback,sliding levelofactivity.Themythisthathigherinterest 4 GreatMonetaryMyths ratesareusually,oroften,associatedwithlower throughmostoftheperiodfrom1930untilthe economicactivity,andlowerrateswithhigher bottomoftheDepressioninMarch1933,mone- activity.Ifyouspendsometimelookingatthe tarypolicywasinfactcontractionary.Ratessim- data,youwillseethatitjustisn’ttruethathigher plywerenotfallingasrapidlyastheyshould ratesaretypicallyassociatedwithloweractivity. have,giventheeconomicfundamentalsofthat Indeed,youwillbestruckbythefactthathistor- period. ically,unemploymenttendstobelowwhen Thereis,unfortunately,nosimplewaytotell interestratesarehighandviceversa.Thiscyclical wheninterestratesarerisingorfallingrapidly patterntointerestratesgoesbacktothemiddle enoughtomaintainabalancebetweentheecon- ofthe19thcentury,atthebeginningofoursys- omy’ssupplyofgoodsanditsdemandforgoods tematicobservationsofinterestratesandthe sothatinflationwillremainlow.TheFederal businesscycle. Reserveevaluatesavastamountofinformation ThereasonforthispatternisthattheFedhas intheprocessofreachingitspolicydecisions. notalwaysbeensuccessfulintimingitspolicy WeintheFedacknowledgethatwedonotalways actionstoachievebalanceinsupplyanddemand gettheanalysisjustright.Butcertainlyforsome atstableandlowinflation.Often,inthepast, yearsnowtheFedhasbeencloseenoughtogetting higherinterestrateswereassociatedwithaboom- thingsrightthattheoutcomesfortheeconomy ingeconomy,andaneconomyinwhichinflation havebeenhighlyfavorable.Fluctuationsinthe wasrising.Also,ofteninthepast,theFeddidnot inflationratehavebeensmall,andthetrendrate actquicklyenoughtopushinterestratesdown ofinflationhasremainedlow.Whatyouwillfind whentheeconomicfundamentalswerepointing lookingatachartcoveringthisperiodisthatinfla- towardaweakereconomy. tionhasremainedremarkablylowandsteady, So,themythisthatFedactiontopropel theunemploymentratehasgraduallyfallento interestrateshigherautomaticallypointstoa today’slevelof4percentandinterestrateshave weakereconomy.Indeed,somemonetarypolicy fluctuatedupanddown.Thereislittleobvious relationshipbetweentheinterestrateandthe mistakesinthepasthavearisenpreciselybecause levelofeconomicactivityoverthelastfiveyears, toomanypeoplebelievedthemyth.Fedpolicy- butwhatlittlewecanobserveisinthedirection makerssometimesrecognizedthatinflationpres- ofhigherrateswhenGDPgrowthishigherand sureswerebuilding,butthoughtthatrisinginterest lowerrateswhenGDPgrowthislower. ratesindicatedthatpolicywasrestrictive.Inmany ofthesecases,however,theFedwasholding interestratesdownfromwheretheeconomic fundamentalswouldhavedriventhem.Asa MYTH FOUR: consequence,theFedwasactuallyfollowingan MONETARY POLICY DECISIONS expansionarypolicyatatimethatinflation ARE FUNDAMENTALLY pressureswerebuilding.Forasimpleanalogy, POLITICAL youcannotassumethatyourcarisslowingjust becauseyouaresteppingonthebrake.Ifyouare Todayweareinthemiddleofaprimary goingdownasteepmountain,youmightnotbe electioncampaign,andinafewmonthswillbe steppingonthebrakehardenough,andyourcar inthemiddleofanationalelectioncampaign. maybepickingupspeed.Similarly,inperiods DiscussingpoliticsandtheFedcanbeasensitive ofeconomicweaknessinthepast,theFedand issue,butIthinkit’sbesttodealwiththisissue manyotherobserverssometimesconfusedfalling forthrightly.Thebottomlineformeiscertainly interestrateswithanexpansionarypolicy.The thatmonetarypolicydecisionsarenotatall mosttragicexampleofsuchamiscalculation political. occurredduringtheearlyyearsoftheGreat Whatismeantbytheclaimthatmonetary Depression.Eventhoughinterestrateswerefalling policydecisionsarepolitical?Onepossible 5 MONETARYPOLICYANDINFLATION meaningisthatFeddecisionsaredesignedto Thereisasubstantialprofessionalliteratureon strengthenthepositionofonepoliticalpartyor theeffectsofinflationonthedistributionof theother.Anotherpossiblemeaningisthatthe income.Thefactthatthegoaloflowinflation FederalReservemakesitsdecisionsforthepur- issharedbybothlow-incomegroupsandhigh- poseoffavoringcertaingroupsoverothergroups. incomegroupssuggeststhatanyredistribution IamconvincedthatFedpolicyisnotpoliticalin effectsofinflationarelikelytobesmall.Indeed, eitheroftheseways. theevidenceisprettyclearthatahigherrateof ItisimportanttounderstandthattheFederal inflationwouldhaveverymixedeffectsinterms Reservehasessentiallyonlyonepolicyinstru- ofredistributionofwealthandincome.Lower ment.Iliketothinkofthatinstrumentasbeing incomepeople,forexample,havemostoftheir therateofmoneycreation,ormoregenerallythe wealthtiedupinassetsthatsufferreducedpur- rateofliquiditycreation,fortheeconomyasa chasingpowerasinflationrises.Bythesame whole.Intheshortrun,theFedcontrolsthecre- token,theirdebtsbecomelessonerouswhenthe ationofliquiditybyadjustingtheintendedfederal inflationrateishigher.However,thosewithin fundsrate.Whetheryoulookatpolicythrougha anyincomeclasshavequitedifferentfinancial moneygrowthlensorthroughaninterestrate situations;withineachincomeclass,unantici- lens,thefactisthatthereisjusttheonepolicy patedinflationhelpssomeandhurtsothers.In instrument.YoucanthinkofFedpolicyeitherin short,thereisnoobviouswaythatthecentral termsofliquiditycreationorinterestrates,but bankcouldaffecttheincomeandwealthpositions notboth,becausetheFedcannotindependently ofhigherorlowerincomegroupsbychoosinga controlliquiditycreationandinterestrates. differentrateofinflation. Withonepolicyinstrument,theFedcanat CouldtheFedadjustthetimingofitspolicy mostachieveonepolicyobjective.FortheFed, actionsintheshortruntofavoronepoliticalparty thatobjectiveistherateofinflation.Thegoalis ortheother?Inprinciple,theanswerisyes,but tokeeptherateofinflationlowandstable.The inpracticetheprotectionsbuiltintothestructure Fedalsohassomefreedomtoadjustthetiming oftheFedmaketheriskremote.I’lldiscussthese ofitspolicyactionstocontributetooveralleco- protectionsinenoughdetailtoconvinceyou,I nomicstability.Forexample,theFOMCreduced hope,thatFedpolicyisnotatallpartisan. theintendedfedfundsratethreetimesinquick IntermsofthebackgroundsofFedpolicy- successioninthefallof1998inaneffort—one makers,Idetectnopredominantpoliticaloutlook. thatturnedouttobequitesuccessful—tokeep MembersoftheBoardofGovernorsareappointed thefinancialdisruptionfollowingtheRussian bythePresident.Thus,giventhatgovernorshave defaultfromaffectingtheU.S.macroeconomy. 14-yearterms,atanyonetimesomegovernors Lastyear,asthefinancialdisruptionfaded,the wereappointedbyaPresidentfromonepolitical Fedtookbackthosethreeratecuts.Thus,theFed partyandsomebyaPresidentfromtheother wasabletotakepolicyactionstoreducerates politicalparty.Moreover,thereisnoconsistent andthenraisethemagaintosmooththecourse patterninthepoliticalaffiliationofthegovernors oftheoveralleconomy,anditwasabletotake appointedbyanyparticularPresident.President theseactionswithoutjeopardizingitsbasicgoal CarterinitiallyappointedPaulVolckerasChair- oflowandstableinflation. man,butPresidentReaganre-appointedhim. SothatiswhattheFedistryingtodo.Isthere PresidentReaganinitiallyappointedAlan anyparticularpoliticalagendatoachievinglow GreenspanasChairman,butPresidentClinton andstableinflation?Ithinknot.Thegoalsoflow twicere-appointedhim. inflationandhighemploymentarebroadlyshared AmongtheReserveBankpresidents,party acrossallsegmentsofU.S.society. affiliationisprettyobviousforsome,likeme, Doeslowinflationtendtoredistributeincome whomayhaveservedinapreviouspositionina awayfromoneincomeclasstowardanother? particularpoliticaladministration.Iamnotatall 6 GreatMonetaryMyths sure,however,ofthepoliticalaffiliationofmostof threattobankearningsbecauseloandefaultsrise. myfellowpresidents.Ifyoureadtheirspeeches, Thus,Ithinkthatbankers,aswellasothersin Idoubtthatyouwillfinditobviouseither. theeconomy,haveastrongreasontofavorcon- MembersoftheboardsofdirectorsofFederal tinuinglowandstableinflation,whichhelpsto ReserveBanksarealsoofvariedpoliticalpersua- maintaincontinuinggrowthinbusinesswithout sion.Hereagain,Ireallydon’tknowwhatthe arecession. politicalpersuasionisoftheboards,including Finally,ifyoubelievethattheFed’sshort-run myown.Ofcourse,Icanmakesomeguesses, policydecisionsarepoliticalinnature,Iurge buttheissuereallydoesnotcomeup. youtotaketimetoreadthetranscriptsofFOMC EachFedboardhasthreeofitsninedirectors policydeliberations.Thetranscriptsarereleased fromthecommercialbankingindustry.Sometimes withalagofaboutfiveyears.Thetranscriptsfor peopleclaimthatcommercialbankersarepre- 1994willbereleasedsoonandtranscriptsformost disposedtohighinterestrates.Thatiscertainly earlieryearsarealreadyavailable.Thetranscript notmyexperiencewithbankersontheSt.Louis istakenfromthetapeofFOMCmeetings;the Fedboard.Iseenoevidencethattheyareuni- onlychangesreflectminorcorrectionstogrammar formlypredisposedineitherdirectionwhenit anddeletionofreferencestoparticularfirmsand comestointerestratechanges.Infact,atleastin foreigngovernmentsthatwouldviolateconfiden- today’seconomy,it’snotsoclearwhethercom- tiality.Ichallengeyoutoreadthosetranscripts mercialbanksbenefitevenintheshortrunfrom andfindanyconvincingevidencethatmonetary higherinterestrates.Commercialbanksliveoff policyissetonthebasisofpoliticalconsiderations. thespreadbetweentheinterestratestheycharge OnefinalconsiderationisthattheFederal andtheinterestratestheymustpaytoattract Reservehaselaborateprovisionspreventing funds.Theprincipleiseasytounderstandby politicalactivitybyReserveBankofficersand consideringabankwithasubstantialcredit-card directors.EachReserveBankhasanethicsofficer business.Credit-cardinterestratesareverysticky; whooverseesthesematters.Youwillnotfind theychangeinfrequently.Thecostoffundstoa FederalReserveofficialsordirectorsinvolvedin bankrespondsprettysensitivelytochangesin anypoliticalcampaigns;theydonotengagein short-termmarketinterestrates.Abankwitha fundraisingforcandidatesorinanyovertpolitical credit-cardbusinessislikelytobeunhappywhen activitywhatsoever.YouwillnotfindanyFederal marketratesrisebecauseitsbusinesswillbeless Reserveofficialsservingasadvisers,unofficial profitable. orotherwise,tothecandidates. Exactlyhowanyonebankisaffectedbyhigher Thebottomline?FederalReservepolicy interestratesisdependentonthenatureofthe decisionssimplyarenotpoliticalinanyusual bank’sbusinessandhowthebankhaspositioned senseofthatterm. itself.Ithinkthatbanksgenerallytendtobenefit intheshortrunwhentheFedlowersinterestrates, becausetheratesbankspayonfundstheyborrow CONCLUDING COMMENTS aretypicallyabitmoreflexiblethantherates bankschargeonthefundstheylend.Thisanalysis Ihavediscussedfourgreatmonetarymyths. isconsistentwithrecentcommentsbysomestock First,thattightmonetarypolicyincreasesunem- marketobserverswhohavearguedthatrising ployment.Second,thattightmonetarypolicy interestratesoverthelastyearexplaintherela- raisesinterestrates.Third,thathigherinterest tivelyweakperformanceofbankstocks. rateswilldepresstheeconomy.Fourth,that Inanyevent,bankmanagersandshareholders monetarypolicydecisionsarefundamentally dohaveanintenseinterestinseeingthatthe political. overalleconomyremainsstable.Anydeveloping Tounderstandwhytheseclaimsaremyths, situationthatmightleadtoarecessionwillbea ithelpstounderstandsomeeconomics.Forinfla- 7 MONETARYPOLICYANDINFLATION tiontoremainlowandstable,interestratesmust sometimesbehigher,sometimeslower.Wemust distinguishbetweenshiftsinsupplyconditions andshiftsindemandconditions.Wemustdis- tinguishbetweenshort-runandlong-runcondi- tions.Ifyouputsomeeffortintounderstanding thebasiceconomicsoftheseissues,andifyou spendsometimereading,youcanformyour ownindependentjudgmentontheclaimsIhave labeled“myths.”Ithinkyou’llreachthesame conclusionIhave—aconclusionIreachedlong beforeIcametotheSt.LouisFedtwoyearsago. 8

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APA

William Poole (2000, February 23). Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/speech_20000224_poole

BibTeX

@misc{wtfs_speech_20000224_poole,
  author = {William Poole},
  title = {Speech},
  year = {2000},
  month = {Feb},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/speech_20000224_poole},
  note = {Retrieved via When the Fed Speaks corpus}
}