Speech

The Critical Role of Economic Education in the Conduct of Monetary Policy HawaiiCouncilonEconomicEducationAnnualMeeting Honolulu,Hawaii April25,2000 Iam delighted to be here today to speak true.Mysecondsubjectwillbethatwemustkeep before the Hawaii Council on Economic ourfocusonthelongrun.JohnMaynardKeynes Education. I have spent most of my life isoftenquotedtotheeffectthatinthelongrun in higher education and now, as a policy wearealldead,butthatisaterriblymisleading official in the Federal Reserve System, I am still thingtosay.Ifwedonotlookatthelong-run intimately involved in education issues. My consequencesofpolicyactions,weareboundto audiences may be different, but the issues are getourselvesintoalotoftrouble. thesame.Imustsay,however,thatitisconsider- Thirdly,I’llemphasizethatpricestability,or ablyeasiertospeaktoyoutodaythantofreshmen lowandstableinflation,isafarmoreimportant at nine in the morning. goalthanmanymaythink.Whenthepricelevelis Iwillproceedbydiscussing,first,whyevery- stableforanextendedperiod,peopletendtotake oneneedstounderstandthebasicsofmonetary pricestabilityforgrantedandfailtounderstand thatmanyothergoodfeaturesoftheeconomy policy.Lotsofpeople,especiallyyoungpeople, dependcriticallyonitscontinuedmaintenance. seemtobelievethatthosepeskysupplyand Bythesametoken,whentheeconomysuffers demanddiagramsaretoodifficultanduninterest- frompriceinstability,manythingsgowrongthat ingtobeworthspendingmuchtimeon.Most shouldbe,butoftenarenotappreciatedtobe, people,though,eventuallyfindthattheycannot linkedtothelossofpricestability. escapeknowingsomethingaboutmortgageinterest Beforeproceeding,Iwanttoemphasizethat ratesandothermundanemattersthatturnoutto theviewsIexpressherearemineanddonot besoterriblyimportantfortheireconomicwelfare. necessarilyreflectofficialpositionsoftheFederal Speakingintheabstractabouttheimportance ReserveSystem.Ithankmycolleaguesatthe ofunderstandingmonetarypolicytakesusonly FederalReserveBankofSt.Louisfortheircom- sofar,however.Togettotherealmeatoftheargu- ments,butIretainfullcreditforerrors. mentrequiresthatweentangleourselvesinalive issueortwo,andspendenoughtimeontheissue tounderstandwhyeveryoneoughttoknowsome- SOME BACKGROUND ON FED thingaboutit.Forthisreason,I’lltacklethree POLICY PROCEDURES issuesthatstrikemeasparticularlyrelevantin today’seconomy.ThefirstissueisthattheFederal Beforediggingintothesubstanceofpolicy,I Reservereallyhasonlyonepolicyinstrument, needtobesurewe’reonthesamewavelengthin orpolicylever.Ifthereisonlyoneinstrument, ourunderstandingofFedpolicyprocedures. thentherecanbe,orshouldbe,onlyonepolicy ThekeyinterestrateforFedpolicyisthefederal goal.I’llexplainwhybothofthesestatements— fundsrate.Thefundsrate,tousemarketlingo,is thattheFedhasonlyonepolicyinstrumentand simplytheinterestratebankschargeeachotheron thatoneinstrumentrequiresonlyonegoal—are loansofthefundstheyholdinreserveaccounts 1 ECONOMICEDUCATION atFederalReserveBanks.Commercialbanksand WHY EVERYONE NEEDS TO otherdepositoryinstitutionsmaintainthese UNDERSTAND MONETARY reservesondepositattheFedinordertomeet POLICY BASICS theirrequiredreservesandtomakepaymentsas checksclearthebankingsystem.Depositoryinsti- Businessenterprisesoftenborrowlarge tutions—or“banks”asIwillcallthemfromnow amountsoffunds,andsotheprobabledirection on—sometimeshavesurplusfundsthattheylend ofinterestratesandthemonetarypolicyconsid- outtootherbanksthathaveadeficiencyoffunds. erationsbehindfutureinterestratesareofdirect Theseloansaretypicallyforonedayatatime,or andimmediateinteresttoeverycorporation. “overnight”inmarketparlance.TheFederalOpen Everyfirmmustalsobeconcernedaboutfuture MarketCommittee(FOMC)conductsmonetary wageandpricedevelopments,whichmeansthat policybydetermininganintended,ortarget, anunderstandingoftheFed’sobjectiveofprice interestrateforfederalfunds.Attheendofeach stabilityanditssuccessinachievingthatobjective ofitsmeetings,theFOMCdirectstheFed’sOperat- isimportantforbusinessmanagers. ingDeskattheFederalReserveBankofNew Eachofusasamemberofaconsuminghouse- Yorktomaintainthefederalfundsratenearits holdalsoneedstounderstandthebasicsofmone- intendedlevel.TheDeskachievesthisobjective tarypolicy.Fromtimetotime,almostevery byplacingadditionalfundsinthemarketwhen householdisfacedwithadecisionaboutpurchas- thefundsratethreatenstoexceedtheintended ingahouseandmustunderstandthebasicsof rate,orwithdrawingfundsfromthemarketwhen mortgagefinance.Thesebasicstodayrequiresome therateisfallingshortoftheintendedlevel. knowledgeoftherelativeadvantagesanddisadvan- Marketparticipantsspendalotoftimeform- tagesoffixed-rateandadjustable-ratemortgages. ingexpectationsaboutthelikelycourseofthe Tounderstandtheconsequencesofchoosingone federalfundsrateinthefuture.Therateona1- ofthesealternativesovertheother,households weekTreasurybill,forexample,reflectsthemar- needtoknowsomethingaboutthebasicsofmone- ket’sbestguessastotheaverageforthefederal tarypolicyandthelikelysuccessoftheFederal fundsrateoverthenextsevendays.Theinterest Reserveinkeepinginflationlowonasustained rateona1-monthobligationreflectsexpectations basis.Inaddition,householdsneedtounderstand aboutthe1-weekrateforthenext4weeks,and whytheFedisdoingwhatitisdoingsothat the1-yearratereflectsexpectationsoverthenext familyfinancialdecisionswillnotbemadeon 52weeks.Continuingthislineofargument,the thebasisofmisinformationaboutmonetarypolicy. 30-yearbondratereflectsexpectationsaboutthe Finally,justasbusinessesneedtoknowsome- next30one-yearrates. thingaboutprices,becausebusinessesbuyand Thispicture,ofcourse,iscomplicatedby sellgoods,andaboutwages,becausebusinesses interestdifferentialsofvariouskinds,butforour hirelabor,soalsohouseholdsmustknowsome- purposesthebigpictureiswhatweneed.Let’s thingaboutthesesameissues.Households,after focusontwokeyelements:First,theFOMCsets all,areontheoppositesideoftheseeconomic theovernightrate,whichquitenaturallyhasa transactionsfrombusinesses.Householdspay significantinfluenceovershort-termrates.Second, thepricesthatbusinesseschargeandreceivethe longer-termratesdependonthemarkets’under- wagesthatbusinessespay. standingthedirectionofmonetarypolicyandall oftheeconomicforcesthatinteracttoyieldthat long-rundirection.Thus,averyimportantrespon- THREE ILLUSTRATIVE ISSUES sibilityfortheFOMCistocommunicateasclearly THAT REALLY MATTER aspossiblethelonger-rundirectionofmonetary policyandtheconsiderationsthatunderliepolicy Theimportanceofunderstandingmonetary decisions. policybasicsreallycomesalivewhenwecon- 2 TheCriticalRoleofEconomicEducationintheConductofMonetaryPolicy sidersomeexamples.I’veselectedthreespecific primarymissionofachievingpricestabilityto examplesthataresimpleandeasytoexplainand bedeflectedbyattemptingtopursueothergoals. yetextremelyimportant. TheissueIwanttoemphasizeisnotthat othergoalsareunimportant.Allofuswantthe One Policy Instrument Means One unemploymentratetosettleataslowalevelas Policy Goal possible,andwewantthestockmarkettobe pricedcorrectly,andwewanttheforeignexchange I’llstartthistopicbymakingastatementthat ratetosettleatanappropriatelevel.ButtheFed soundstechnicalandcomplicated,butreallyisn’t: simplydoesnothavepolicyinstrumentstoachieve Inengineeringcontroltheory,weknowthatto allofthesegoalsandmustinsteadconcentrate achieveNgoalsrequiresatleastNinstruments. onthegoalthatisitsdirectresponsibility.To Forexample,ifwehavethreegoalslikecontrol- repeat,thatgoalismaintaininglowandstable linganairplane’sspeed,altitudeanddirection, inflation. theplanemusthaveatleastthreecontrolinstru- Nowthisbasicviewcanandshouldbemodi- ments.Thethrottleinstrumentcontrolsspeed, fiedjustabit.ItispossiblefortheFedfromtime therudderincombinationwithsomeothersur- totimetoadjustmonetarypolicytocounterprob- facescontrolsdirection,andtheelevatorsonthe lemsinachievingothergoals,butonlytothe horizontalstabilizercontroltheplane’saltitude extentthatsuchpolicyadjustmentsdonotdamage bydirectingitupordown. thelong-runcauseoflowandstableinflation.For Consideranothersimpleexample.Withtwo example,inthefallof1998,theFOMCreduced objectives,suchascontrollingacar’sspeedand theintendedfederalfundsratetorespondto direction,thedriverneedstwocontrolinstru- financialdisturbancesthatarosefollowingthe ments—asteeringwheelandanaccelerator. Russianbonddefault.Easingmonetarypolicy Whatistherelevanceofallthisformonetary temporarilydidassisttheeconomyinworking policy?TheFederalReservehasonlyonemain throughthesefinancialdisturbances,withouta policyinstrumentatitsdisposal.Thatinstrument long-runconsequenceforthegoaloflowand istherateofcreationofmoney,ormoregenerally, liquidity.TheFedexercisescontrolovermoney stableinflation.Byrespondingtothedisturbance, creationonaday-by-daybasisbyadjustingthe theFedwasabletokeepthoseproblemsfrom intendedfederalfundsrate.Withonlyonepolicy havinganimpactonemploymentandeconomic instrument,theFedcanpursuesuccessfullyonly activity.Theprincipleinvolvedhereiswellunder- onepolicygoal.Thatgoalislowandstableinfla- stoodincontroltheory.Theapplicationofapar- tion,orpricestability,dependingontheexact ticularinstrumentmayhavesimultaneouseffects phraseused. onseveralgoals.Forexample,applyingmore ThissimplefactthattheFedhasonepolicy powertoanairplanewillincreaseitsrateofclimb. instrumentandmust,therefore,decidewhich Butthepointisthattofullyachievegoalsforboth singlegoalitwillpursueisoftremendousconse- altitudeandspeed,theaircraftmusthavemore quence.PeopleofteninsistthattheFedoughtto thanathrottle. pursueotherobjectives,suchasreducingthe Iinviteyoutokeepyoureyesandearsopen unemploymentrate,stabilizingtheforeign forexamplesofpeopleurgingtheFedtopursue exchangerate,ornudgingthestockmarketupor multipleobjectives.Isuspectthatyouwillfind down.TheFederalReservecannotinfactpursue manysuchexamplesandthatalittlethoughtwill multipleobjectivesandhopetoachievethemall. indicatejusthowuninformedthesepolicypro- Giventhatthemainconsequenceofexcessiveor posalsare.ItisimportantfortheFedtomaintain deficientliquiditycreationisinflationordeflation, itsfocusonwhatitcanreasonablyaccomplish, eitherofwhichcreatesawholehostofother andnottopermitotherissuestodeflectitfrom problems,theFederalReservemustnotallowits itsprincipalresponsibility. 3 ECONOMICEDUCATION It’s the Long Run That Matters Policymakersoftenfindthemselvesconfronted byapublicclamortodosomethinginresponse Oneofmyfavoriteformatsforastudentterm toashort-runproblem.Onoccasion,ashort-run paperwastoaskthestudenttoreviewaparticular policyresponsecanbeconstructive,aswasthe economicepisodebygoingbacktonewsmaga- caseintheRussianbonddefaultin1998.But zinesandnewspapers.Askingastudenttoread moreoftentheappropriateadviceis,“Don’tjust thenewspapersforafewweeksoneithersideof dosomething,standthere!” thestockmarketcrashesof1929and1987,orover Oneargumentforkeepingpolicyonasteady, afewmonthsduringtherecessionof1982,ora evencourseisthatpolicyactionsinresponseto fewmonthsasinflationrosesharplystartingin short-rundisturbancesareseldomsuccessful.But thefallof1973,isanexcellentwaytogetthe theargumentisreallydeeperthanthat.Produc- studenttodevelopasenseoftheseevents. tivitygrowthandjobcreationinamarketeconomy Economichistorianswritingaboutsuch aredrivenbythousandsuponthousandsofdeci- episodesdistillthedetailedrecordintothekey sionsintheprivatesector.Animportantrespon- eventsandpolicydecisions.Thejobofthehisto- sibilityofgovernment,includingtheFederal rian,ofcourse,istoputeventsintoalonger-run perspectivebyexaminingthekeymilestones, Reserve’sresponsibilityformonetarypolicy,is policydecisions,andcausalmechanisms.Butat tosetastableandpredictablecoursewithinwhich anygiventime,peoplegetcaughtupintheevents privatedecisionscanbemadeefficiently.Onthe ofthedayandfinditdifficulttoputtheseevents whole,householdsandfirms,interactingthrough intotheappropriateperspective. markets,domakeefficientdecisionsaboutprices AsIreflectonhoweventsunfold,Iamalways andquantitiesofgoodsandservices.Excessive struckbytheenormousamountofattentionpaid governmentactivismcaninterferewiththeeffi- toinformationthatwill,tothehistorian,beat ciencyofthosedecisions. mostrandomnoise.Perhapsyouhavehadthe Ifyouhaveanydoubtsabouttheoverriding strangesensation,asIhavehadmoretimesthan importanceofthelongrun,trytothinkbackto Iliketoadmit,ofpickingupanewspaperand thedetailedeventsofayearortwoago.Ifyou afterreadingforafewminutesdevelopinga startreadingnewspapersseveralyearsold,you strangesensethatyoumusthavereadthispaper willfindyourmemoryrefreshedbutyouwillbe before.Ilookatthedate,anddiscoverthatI’ve impressedbyhowtrivialinthelightofsubsequent pickedupanewspaperseveralweeksold.I’ve developmentsmostofthoseday-to-dayevents alreadyreadthepaperandhavediscardedfrom were. memoryalmosteverysinglebitofinformationin it.Yet,alltoomanypolicypositionsaredriven Price Stability Is More Important Than bythetrivialinformationthathappenstohitthe You May Think headlines. TheultimategoalofFederalReservepolicy Thelongrunis,ofcourse,thesumofaseries ofshortruns.Oneyearisthesumof12months, istopromotemaximumsustainableeconomic andonedecadethesumof10years.Oureconomic growth.Weemphasizetheimportanceofprice well-beingdependsmostlyonaveragesovera stabilitybecausethatisthesinglemostimportant decade,andonlytoarelativelysmallextenton contributionthatmonetarypolicycanmake fluctuationsaroundthoseaverages.Policymakers towardachievingthedeeperobjectiveofmaxi- usuallyprefertominimizefluctuationsaround mumsustainableeconomicgrowth.TheFederal thelong-runtrends,butthegovernment’spower Reservealsocontributestosociety’sgrowthgoals todosoisoftenverylimited.Thus,akeyobjective bysupervisingandregulatingbankstomaintain forpolicyistopreventshort-runfluctuations asoundbankingsystemandbyprovidingefficient fromaffectingpolicyinsuchawayastodrive paymentservicessuchascheckprocessingand theeconomyoffthedesiredlong-runtrack. electronicpaymentmechanisms. 4 TheCriticalRoleofEconomicEducationintheConductofMonetaryPolicy Withregardtomonetarypolicy,toofewpeople economyarerelatedtothepricestabilitythe seemtounderstandhowgreatlypricestability economyhasenjoyedinrecentyears.Pricesta- contributestotheeconomy’sgeneralwelfare. bilityisanabstractgoalandisnotmuchworth Pricestabilitywillnotbyitselfguaranteesuccess, pursuingforitsownsake.Butsomanyaspects fortherearemanyothercooperatingconditions ofoureconomicwelfarearedirectlyandindirectly necessary.Butpriceinstabilitywithoutquestion connectedtopricestabilitythatitisimportant canguaranteesignificantproblemsinanyecon- nottounderestimatetheimportanceofachieving omy.Thepublicoftenattributestheseproblems thatgoal. tonon-monetaryconditionswhentheyinfact IsaidamomentagothatIwasnotgoingto stemfrommonetaryinstability. extendthelistofillsfrompriceinstability,and TheU.S.economytoday,andforthepast thevirtuesofpricestability,butIwillbreakthat severalyears,hasbeenenjoyingextraordinarily promisejustbrieflytocommentontheeconomics lowunemploymentandrapidjobgrowth.Ibelieve oftheeducationsector.Ourcurrentprosperity thatstablemonetaryconditionsyieldingalow hasgeneratedlargeamountsoftaxrevenueatall andstablerateofinflationandsolidexpectations levelsofgovernment.Theseresourcesareavail- ofcontinuingstabilityhaveplayedasubstantial ableforagreatvarietyofpublicresponsibilities, roleintheeconomy’ssuccessinthelabormarkets. includingeducation.Withuniversitybudgets U.S.inflationinthe1970scertainlycontributed growing,Iknowthattheuniversitydemandfor substantiallytotheemploymentvolatilityofthat economistsishigh;thatdemandmakesitdifficult period.Therecessionsof1973-75and1981-82 forustohiretheyoungeconomistsweneedfor werethemostseriousdownturnssincetheGreat ourstaffattheSt.LouisFed.Incontrast,during Depression,andthesedownturnsaroseonthe the1970s,manystatebudgetswereundersub- backsofacceleratinginflationandexpectational stantialpressurebecauserisingpriceswereout- errorscausedbyunanticipatedchangesinmone- runningtheavailabletaxrevenues.Someofyou mayrecalltheperiodsofstringencyduringthose tarypolicy.Today,despiteaneconomicexpansion years. ofrecordlength,weseenosignsthattheexpan- Moreover,therelativestabilityofwagesand sionisclosinginonoldage.Ifinflationgetsaway priceshasmadethejobofeducationalbudget fromtheFedtoanysignificantdegreeintheyears planningaloteasier.Allofusmayhavetoscram- ahead—andIampushingwitheveryboneinmy bletofindthetalentweneed,butwedoour bodytodowhatIcantomakesurethatcircum- scramblingwithinanenvironmentinwhichwe stancedoesnotfaceus—thenthedangersof canreasonablyplanourbudgetoutlays.Theend recessionwillsurelyrise. resultisgreaterefficiencyinmatchingtalentand Monetaryinstabilityandinflationdamage resources.Clearly,also,withthejobmarketso stabilitynotonlyinthelabormarketbutalsoon strong,thereareampleemploymentopportunities ahostofotherfronts.Someofyoumayrecallthe forourstudentsastheyfinishtheirdegrees. difficultypeoplehadinbuyinghomeswhenmort- gageratesaveragedmorethan15percentin1982. Duringmuchofthedecadeofthe1970s,falling CONCLUDING OBSERVATIONS stockandbondpricesdamagedincomesecurity forolderAmericans.Publicconcernoverinflation Bynow,I’msureyouhaveagoodideaofthe ledtotheunwisepoliticalresponseofwageand thrustofmythinking.Iwill,however,pointout pricecontrolsin1971,andthosecontrolscreated thatIhavediscussedtheseandothermonetary avastarrayofotherproblems. policyissuesthatreallymatteratgreaterlength Icouldextendthislisttogreatlength,butwill inanumberofspeechesoverthelasttwoyears notdoso.Mypointisthatmanyfeaturesofthe thatIhavebeenattheSt.LouisFed,andI’llput 1970swererelatedtotheinflationaryenviron- inaplugforourwebsitethatcontainsthose ment,andmanyfavorablefeaturesoftoday’s speeches. 5 ECONOMICEDUCATION Finally,then,letmecirclebacktomymain expectationthattheinterestratereceivedwillbe themeabouttheimportanceofpublicunderstand- higherinthefuture.Tomakethesedecisionsintel- ingofthesemonetarypolicyissuesforthejobof ligently,borrowersandlendersneedtounder- theFederalReserveSystem.Somepeoplemay standthebasicsofmonetarypolicy.Otherwise, taketheviewthatthepublicshouldsimplyput theywillmakemistakendecisionsthatwillulti- goodpeopleinofficeandthenallowtheseexperts matelydamagetheeconomy’slong-rungrowth. todothejobrightwithoutfurtherpublicinter- Thus,inpursuingthegoalofmaximumsustain- ference.Ifthatviewwerecorrect,thentherewould ableeconomicgrowth,theFedmustbeconcerned benoneedforthepublictounderstandmuch withmuchmorethansettingtheintendedfederal aboutwhatwedo. fundsrateatthenextFOMCmeeting.Weneed Irejectthisviewfortworeasons.First,my todothebestjobwecaninconveyingtothe observationofAmericanpoliticstellsmethat,in marketthereasoningandoutlookformonetary avigorousdemocracy,peoplewillnotsitback policyandtheeconomymoregenerally.Wecan- andlettheexpertsdotheirownthing.Infact,I not,ofcourse,forecasttheunforecastable,but thinkthevotersarerighttopayattentiontowhat wecanmakeclearourconvictionthatmaintaining wedo,forexpertsinpowerdonotalwaysmake lowandstableinflationisourprimaryresponsi- theproperdecisions.Whereveryoucomeouton bility.Wecanalsoprovideasenseofhowwego thisissue,thefactisthatvotersdonotignorewhat aboutrespondingtoandanalyzingtheflowof wedo,andthereforeitisintheinterestofthe incominginformation. nationthatvotersunderstandwhatgoodpolicy Lookingatthisargumentfromabusiness isallabout.Otherwise,theyandtheirrepresenta- perspective,weknowthatefficientbusiness tivesmaydemandtheFederalReservetomovein managementrequiresfirmstomakecorrectdeci- directionsthatwillnotturnouttobeconstructive. sionsinhiringlabor,buildingplantandequip- ThereisanotherreasonfortheFederalReserve ment,designingandpricinggoodsandservices, tobeconcernedaboutpublicunderstandingof andsoforth.Thesedecisionsincludeefficient monetarypolicyissues.Inmybriefdescription financialdecisions.Andthosedecisionsinturn ofmonetarypolicyatthebeginningofthisspeech, requiresomeknowledgeofmonetarypolicyissues. IpointedoutthattheFeddirectlysetsanintended I’msurethatmostofyouinthisaudienceare ratefortheovernightfederalfundsratewhilethe convincedoftheimportanceofeconomicedu- marketsetslonger-terminterestratesonthebasis cation.Weneedtoconvincethosewhoteach ofexpectationsaboutthefuture.Howcanthe English,foreignlanguages,history,andother marketsetthe10-yearbondrateorthe20-year non-economicssubjectsthatatleastatasteof mortgageratewithoutknowingsomethingabout economicsisgoodforeverystudent.Everyone monetarypolicy?Theinteractionofborrowers needstounderstandthebasicstomakesound andlendersinthemarketplacedeterminesthose decisionsinhouseholdfinancialmanagement. longer-termrates.Mortgageborrowers,forexam- Understandingthebasicsofmonetarypolicy ple,needtomakejudgmentsaboutwhetherthe willpaydividends,bothforindividualsasciti- currentrateislikelytoreflectagoodbuyor zensandforthemasmembersofhouseholds whetherthemortgageratemightbelowerinthe andintheircapacityasproductiveemployees comingmonths.Similarly,lendersneedtodecide ofbusinesses. whentolendandwhentohangontofundsinthe 6

William Poole (2000, April 24). Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/speech_20000425_poole

@misc{wtfs_speech_20000425_poole,
  author = {William Poole},
  title = {Speech},
  year = {2000},
  month = {Apr},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/speech_20000425_poole},
  note = {Retrieved via When the Fed Speaks corpus}
}