speeches · October 13, 2000

Speech

William Poole · President

Confidence and Central Banking FainLectureinCelebrationofGeorgeBorts’sFiftiethYearasa ProfessorofEconomicsatBrownUniversity BrownUniversity Providence,RhodeIsland October14,2000 It is an honor for me to return to Brown Mytopicisfamiliartoalleconomistsand Universitytoparticipateinthiscelebra- manynoneconomists.Weknowthatsuccessful tion of George Borts and his 50 years as a marketeconomiesdependonstableandpredict- professor of economics at Brown. George ableeconomicpolicies.Whenitcomestomone- hasbeenawonderfulfriendtomeovertheyears. tarypolicy,thekeyissueistheresponsibilityof He is a fine economist and one of a handful of thecentralbanktomaintainthepublic’sconfi- key university leaders on the Brown faculty. He denceinthepurchasingpowerofmoney. hasshapedBrownandtheeconomicsdepartment I’mgoingtodiscussthetopic,however,ina in ways visible and not so visible. novelwaybytyingtogetherconfidenceinthe Wearegoingtoeat,drink,andbemerryalittle largewithconfidenceinthesmall.Thelargeissue later,andthatiscertainlyappropriateforthis concernsstabilityofthepurchasingpowerof event.ButnocelebrationofGeorgewouldbecom- moneyinthelongrun.Thesmallissueconcerns pletewithoutaseriouseconomicsdiscussion. theabilityofthemarkettopredictthecentral Duringmy24yearsatBrown,GeorgeandIhad bank’spolicyactions.By“small”Idonotmean numerousconversationsabouteconomicissues— “unimportant”butrathersmallintime.Aswe’ll usuallypolicyissues,forthoseweretheoneswe seeinamoment,intheUnitedStatestodaythe weremostinvolvedinwithourownwork.Many marketisquiteadept—amazinglyso,Ithink— oftheseconversationswereoverlunchattheIvy atpredictingwhattheFederalOpenMarket RoomortheFacultyClub,mostoftenwithcol- Committee(FOMC)isgoingtodoatitspolicy leaguesfromeconomicsandotherdepartments meetings.Thetwotopics—thelargeoneandthe aroundthetable.SoIthinkitfittingthatIdiscussa smallone—areconnected.Formarketparticipants monetarypolicyissuethatisimportantnotonly tobelievethatthecentralbankiscommittedto toeconomistsbutalsotoeverymemberofour thepricestabilityobjective,theymustalsobelieve society. thatthecentralbankhastheknowledgeandwill Beforeproceeding,Iwanttoemphasizethat toachievethatobjective.Thefactthatthemarket theviewsIexpressherearemineanddonotnec- canpredictFedpolicyactionsFOMCmeetingby essarilyreflectofficialpositionsoftheFederal meetingsuggeststhatmarketparticipantsunder- ReserveSystem.IespeciallythankmySt.Louis standhowtheFedevaluatesthecomplexsetof Fedcolleague,BillGavin,forhisextensiveassis- informationuponwhichpolicydecisionsare tanceinpreparingthislecture.However,Iretain based.1MarketunderstandingofwhytheFed fullresponsibilityforerrors. doeswhatitdoesisessentialtothemarketshav- 1 Forresearchunderlyingthisthemeinthelecture,seePoole,WilliamandRasche,RobertH.“PerfectingtheMarket’sKnowledgeofMonetary Policy.”JournalofFinancialServicesResearch,December2000,18(2/3),pp.255-98. 1 MONETARYPOLICYANDINFLATION ingconfidencethattheFedwillbesuccessfulin andthe30-yearTreasurybondratedependson maintainingpricestability. expectationsaboutthenext301-yearrates. Beforedivingintomytopic,itisworthempha- Expectationsaboutallofthesefutureinterest sizingthatU.S.prosperityhasthecharacteristics ratesdependonexpectationsaboutFedactions ofathree-leggedstoolandthatalllegsareneeded tochange,ornottochange,theintendedrate. forthestooltostand.Onelegistheentrepreneur- Andthoseexpectationsinturndependonexpec- ialdriveandinventivenessoftheprivatesector. tationsabouteventsandnewinformationthat Thesecondlegisthestabilityofgovernment mayleadtheFedtoaltertheintendedrate.The financesandtheregulatoryenvironment.The maineffectofmonetarypolicy,therefore,operates thirdisconfidenceinthefinancialenvironment, throughtheseexpectationsaboutfuturepolicy characterizedbysustainedlowandstableinfla- andeventsthatwilldrivefuturepolicy.Weknow, tion.ItisthisthirdlegIamdiscussingtonight, forexample,thatchangesinthehomemortgage ratecanhavelargeeffectsonhousingsalesand buteveryoneshouldunderstandthattheother construction.Themortgageratetodayistied twolegsarejustasimportant. closelytootherlong-termratesinthecapital markets,andalltheseratesaretiedtoexpecta- tionsaboutfutureFedpolicy. FORECASTING FED POLICY NowlookatFigure1,whichreportsdailydata DECISIONS fromthefuturesmarketforfederalfunds.The Let’sbeginbylookingatsomerecentevents futuresinterestrateshownhereisthemarket’s infinancialmarkets.I’llexaminetheseeventsby bestguessabouttheaveragefedfundsratefor usingseveralfigures,whichappearattheendof June2000.Thefigurealsoshowsthelevelofthe thetextandinahandouteveryoneshouldhave. Fed’stargetforthefederalfundsrate.OnMay16, theFOMCraisedtheintendedratefrom6percent Alittlebackgroundfirst.TheFOMC,theFed’s to6½percent.Thisfigureshowstheinterestrate mainmonetarypolicybody,implementsmone- fromtradinginthefuturesmarketforthe30days tarypolicybysettingatargetlevelforthefederal beforeandthe30daysafterthemeeting. fundsinterestrate.TheFedcallsthistargetthe Theinterestingthingaboutthisfigureisthe “intendedrate.”Federalfundsaresimplybank accuracyofthemarket’sforecastdespitethefact reservesheldondepositattheFederalReserve thatafedpolicyactiontochangetheintended banks.Commercialbanksborrowandlendthese rateby50basispointsisarareevent.Thefirst fundstoeachotheronanovernightbasis.The tradingdayshownonthefigureisApril4.On FederalReservecancontroltheinterestratein thisday,theintendedratewas6percent.The thismarket—thefederalfundsrate—byadding Junefedfundsfuturescontractpricereflecteda ordrainingbankreserves. marketexpectationthattheaveragefedfunds ManyobserversattributetotheFedtheability rateinJunewouldbe6¼percent.WhentheFed tocontrolallinterestrates.Infact,theFed’scon- changestheintendedrate,thechangeisusually trolovermarketinterestratesotherthanthefed 25basispoints,andthatiswhatthefuturesmarket fundsrateisindirectandoperatesthroughmarket wasexpecting.TheJunefuturesratewassteady expectationsaboutpolicyobjectivesandfuture untilthelastweekofAprilwhenitjumpedpretty policyactions.Theinterestrateon,say,aTreasury quicklyinacoupledays.Thenitcontinuedto billwitha1-monthmaturityissetinacompetitive riseduringthenextfewweeks,graduallyincreas- marketwithnodirectFederalReserveinterven- ingto6½percent.OnMay16,theFOMCvoted tion.The1-monthratedependsimportantlyon toraisetheintendedrateto6½percent.Sinceit marketexpectationsabouttheaveragefedfunds isunlikelythattheFedwouldraisethetarget rateoverthenext30days.A1-yearratedepends betweentheFOMCmeetings—thenextmeeting onexpectationsaboutthenext121-monthrates, washeldonJune27-28—byMay15themarket 2 ConfidenceandCentralBanking Figure 1 Fed Funds Futures and the Fed’s Interest Rate Target perfectlypredictedwhattheFOMCwoulddoat ontheleftsideofFigure2showexampleswhere itsmeetingthenextday. thepolicydecisionwascorrectlyanticipated.The Whatdowemakeofthissituationinwhich twoontherightshowexampleswhereitwasnot. themarketcorrectlyforecastswhattheFedis Let’slookatthesecasesalittlefurther. goingtodo?IstheFedjustfollowingthemarket? TheupperleftpanelofFigure2showstrad- IstheFedleakingtothemarketwhatitintends inginthefuturescontractforSeptember1990and theFOMCmeetingheldAugust16,1990.Inthis todo?Isitagoodthingthatthemarketcanpre- case,thefuturesmarketexpectedarelativelylarge dictFedactions?Toanswerthesequestionsit (50-basis-point)increaseintheintendedfedfunds helpstoconsidertherelationshipbetweenthe rate,andtheFOMCraisedtherate50basispoints. futuresmarketandFedpolicyactionsinmore ThiscaseisliketheoneexaminedinFigure1. detail. TheupperrightpanelofFigure2shows tradinginthefuturescontractforJanuary1991 andtheFOMCmeetingheldDecember18,1990. FOUR POSSIBLE SCENARIOS Beforethemeeting,themarketswerenotantici- Figure1illustratesthesituationinwhichthe patingthattheFOMCwouldreducetheintended rate;theratefortheJanuaryfuturescontractdid marketcorrectlyforecastsaFeddecisiontochange notfalluntilaftertheFOMCacted.Infact,during theintendedrate.Infact,therearefourpossible thelifeofthiscontract,theFOMCreducedthe combinationstoconsider.TheFedmightchange fedfundstargetthreetimesandeachchange theintendedrate,ornotchangeit,andineach appearstohavesurprisedthemarket. casethemarketmightcorrectlyforecasttheFed’s ThetwopanelsinthebottomhalfofFigure2 decision,ornotforecastcorrectly. showexampleswheretheFOMC’sdecisionwas Figure2containsamatrixofactualexamples toleavetheintendedrateunchanged.Thebottom foreachoutcomefromthefedfundsfuturesmar- leftpanelshowstradinginthefuturescontract ket.Itispossiblethatthemarketanticipatesthe forJune1995andtheFOMCmeetingheldMay policydecisionorthatitdoesnot.Thetwofigures 23,1995.Inthiscase,themarketsexpectedno 3 MONETARYPOLICYANDINFLATION Figure 2 Four Possible Scenarios changeinthefedfundstargetandtheFOMCleft tiondata.Arelativelysmallpartofthechanges thetargetunchanged. inthefuturesratescomesondaysFedofficials Finally,thebottomrightpanelofFigure2 givespeechesortestimony.AlthoughRasche showstradinginthefedfundsfuturescontract andIdidnotinvestigatetheissueofleaksinour forAugust1994andtheFOMCmeetingheld research,Iamconvincedthatleaksareextremely July6,1994.Beforethemeeting,themarkets rare.IknowofonlyoneexampleofaleaksinceI wereanticipatingalargeincreaseinthetarget arrivedattheSt.LouisFed—itreceivedattention rate,buttheFeddidnotchangetherateatits inthepressinthespringof1998—anditonly Julymeeting.However,inthiscasethefutures indirectlyconcernedtheprobablefuturesetting ratedidnotchangemuchafterthemeeting;the oftheintendedfundsrateanyway. marketwasstillexpectingtheFedtoact,which iteventuallydidatitsmeetingofAugust16,1994. BeforeIgetintothissubjectanyfurther,let UNDERSTANDING MARKET mementionbrieflyafewgeneralfindingsfrom SUCCESS IN FORECASTING FED myresearchonthissubject,conductedjointly POLICY ACTIONS withmycolleagueBobRasche.Forthoseinter- ested,theworkingpaperinallitsmathematical I’mnowgoingtoillustratethekeyissues andstatisticalgloryisavailableontheSt.Louis concerningmarketsuccess,orlackthereof,in Fed’swebsite.Twogeneralizationsfromthis forecastingFedactionsbyanalyzingmoreclosely research:First,theaccuracyofmarketpredictions thecasediscussedinFigure1.Let’sputasidethe ofFedpolicyimproveddramaticallyin1994. relativelyinfrequentcasesinwhichspeechesor Second,mostofthechangesinthefedfunds testimonybyFedofficialsseemtotelegraphFed futuresratesaredrivenbyeconomicnewssuch intentions.AndIalsowanttoputasidethehypoth- asthemonthlyemploymentreportandtheinfla- esisthattheFedissimplyfollowingthemarket, 4 ConfidenceandCentralBanking Figure 3 June Contract for Fed Funds and Economic News becauseI’mconvincedfrommyownobservation basispoints,atitsmeetingonMarch21.Aswe oftheprocessthatthishypothesisisnottrue. alreadysawinFigure1,thefinal,50-basis-point IfthemarketcanpredictFedpolicyactions increasecameonMay16. quiteconsistently,thenFedbehaviormustbe TheopeningpriceofthecontractonJanuary24 systematicandregularenoughthatthemarket impliedaJunefedfundsrateof6.14percent. canmakeaccuratepredictions.Thus,theability Privateforecasterswereexpectingsomeslowing ofthemarkettopredictFedpolicyactionsmeans intheeconomy.Forexample,theJanuaryBlue thatthemarketunderstandstheFed’sobjectives Chipconsensusforecastwasfor3.0percentreal andtheFedandthemarketsarereadingtheflow grossdomesticproduct(GDP)growthin2000:Q1 ofincominginformationthesameway.Inthis and2.9percentfortheyear.Theupwardtrendin situation,Fedpolicyadjustmentswillnottake inflationthathadoccurredin1999wasexpected marketsbysurprise. tocontinuein2000.OnewaytointerprettheJune NowlookatFigure3.Thisfigureprovidesa fedfundsfuturesrateof6.14percentonJanuary24 moredetailedexaminationoftradingintheJune isthatslightlymorethanhalfthemarketpartici- 2000fedfundsfuturescontractfromtheinitial pantsthoughttheFed’stargetratewouldbe6¼ tradeonJanuary24,2000,tomaturityonJune30, percentinJunewhiletherestthoughtitwould 2000.Thefigurealsoincludesthehistoryofthe remainat6percent.Alternatively,marketpartici- fedfundstarget,whichstoodat5½percenton pantsplacedaprobabilityabitabove0.5that January24;theFOMCraisedthetargetto5¾per- theFedwouldraisetheintendedrateby25basis centatitsfirstmeetingoftheyearonFebruary1-2. pointsandaprobabilityabitbelow0.5thatthe TheFOMCraisedthetargetagain,byanother25 Fedwouldleavetheintendedrateunchanged. 5 MONETARYPOLICYANDINFLATION Figure3includesverticallinesondayswhen increasewaswellanticipatedbythemarket.As therewererelativelylargechangesintheinterest canbeseeninFigure3,atthispointthefedfunds rateontheJunefuturescontract.Thethreshold futuresrateforJunewas6.24percent,indicating I’veusedfordefininga“relativelylarge”change thatthemarketexpectedanother25basispoint was±5basispoints.Duringthelifeofthiscon- increaseattheMayFOMCmeeting. tract,therewere8daysonwhichtheabsolute Duringthethirdepisode,thefedfundsfutures changewas5basispointsorlarger.Thesedays ratefell10pointsonApril4andthenbounced aresortedintofourepisodes. backup5pointsonApril5.Itisnotclearwhat ThefirstepisodeincludedaFridayanda wasthecauseoftheinitialdecline.Thestock Monday,January28and31.OnFriday,January markethadbeenveryvolatileonthe4th—the 28,thefedfundsfuturesraterose9basispoints. DowJonesindustrialsfellover500pointsearly Onthatday,the1999fourthquarterGDPdata inthedayandthenrecoveredtofinishtheday werereleasedshowingthatrealGDPhadgrown downonly57.Onthe5th,theDowfellanother 5.8percentatanannualrate,wellabovemarket 131points,butGreenspangaveaspeechthatleft expectations.TheJanuaryBlueChipconsensus, marketsbelievingtheFedwouldliftthefedfunds forexample,hadbeen4.5percent.Inflationalso targetinMay.Attheendofthisepisode,thefed cameinhigherthanexpected—2.0versus1.6 fundsfuturesrateforJunewas6.28. percentatanannualrate.OnMonday,thestock ThefinalepisodeoccurredonApril27with marketsrosesharplyandthefedfundsfutures thereleaseoftheadvanceGDPreportforthefirst rateroseanother5basispointsasmarketsdigested quarter.ThisreportshowedthatrealGDProseat theunexpectedlygoodnewsabouteconomic a5.4percentrateinthefirstquarter,withcon- growthandtheeffectthatitwashavingonfore- sumerspendingjumping8.3percent,whichwas castsforfutureinterestrates.Afterreceivingthis thelargestquarterlyincreaseinmorethan17 information,themarketexpectedthefedfunds years.Laborcostsrose4.3percentandconsumer targetratetoaverage6.25percentinJune. pricescontinuedtorise.Itisinterestingtonote Thesecondepisodeincludedariseandthen thatthenewswasexceptionalinoneway:The adeclinesurroundingFedChairmanAlan marketwassurprisedbybothhigherthanexpected Greenspan’scongressionaltestimonyaboutmone- realgrowthandhigherthanexpectedinflation. tarypolicy.Thefirstdayofhistestimonywason Since1994,therehadbeenmanyupsidesurprises February17.Thatdaythefedfundsfuturesrate aboutrealGDPgrowth,buttheyhadtypically forJunerose6basispointsto6.27percent.The beenaccompaniedbylowerthanexpectedinfla- nextday,theWallStreetJournalreported, tion.TheWallStreetJournalreportedthat,“The “GreenspansignaledthattheFedwillkeepboost- inflationnewsbooststheoddsthattheFedwill ingratesunlessbothconsumerspendingandthe soonraiseinterestratesbyanaggressivehalfa stockmarketquicklycooldown.” percentagepoint.”Thefedfundsfuturesmarket OnFebruary22,thefedfundsfuturesrate seemedtoagreeastherateroseby11basispoints fell6basispoints.Therewerenosignificanteco- nomicdatareleased,andsowecannotlinkthat onthatdaytocloseat6.41.Theratethenrose declinetoanyparticularpieceofnewinforma- graduallyto6.49ontheFridaybeforetheMay16 tion.OnFebruary24,thefedfundsfuturesrate meeting. fellanother5basispointsafterthegovernment I’verecountedthestoryoftheJune2000fed reportedthatordersfordurablegoodsfell1.3 fundsfuturescontractinsomedetailtoillustrate percentinJanuary,suggestingthattheeconomy ageneralpoint.Howcanthemarketparticipants mightbeslowingabit. successfullypredictwhattheFOMCwilldoat TheFOMCdidraisethefedfundstargetto6 itsnextmeeting?Thatis,howdotheyknowthe percentonMarch21;fromexaminingtheApril interpretationtheFOMCwillplaceontheflow fedfundsfuturescontract,weknowthatthis ofincominginformation,suchasthatrecounted 6 ConfidenceandCentralBanking inthehistoryoftheJunefuturescontract?Part actionsbecausethetimingofthepolicydecisions oftheansweristhatmarketparticipantscarefully betweenscheduledFOMCmeetingscouldnot followspeechesbyFOMCmembers,especially bepredicted. thosebythechairman,AlanGreenspan.The trackrecordofFOMCactionsisalsoobviously important.UnderstandinghowtheFOMChas CONFIDENCE IN THE CENTRAL reactedtoinformationinthepastaidsinpredict- BANK inghowtheCommitteewillrespondtosimilar Aprincipalresponsibilityofthemonetary informationinthefuture. authoritiesineverycountryistomaintainthe Marketparticipantspulltogetherothertypes purchasingpowerofthecountry’scurrency. ofinformationaswell.Theyreceivetheminutes Monetaryresponsibilitiesaresplitbetweenthe oftheFOMCmeetingswithasixorsevenweeks financeministry(ortreasury)andthecentral delay,afewdaysafterthenextscheduledmeeting. bank.Thefinanceministrymanagesgovernment Theseminutesrevealthetopicsdiscussed,sum- finance,includingtaxcollection,andthecentral marizeviewsaboutthestateoftheeconomyand bankmanagesthecreationofmoney.Inmost describethereasonsfordissentingvotes.The countriestoday,thecentralbankhasasubstantial minutesarethorough,whichprovidesanimpor- degreeofindependencefromthegovernment, tantvehicleforkeepingthemarketsandthe andhasassignedtoitthegoalofmaintainingthe publicwellinformedaboutFedthinking. purchasingpowerofmoney.Independenceseems MarketshavebeenabletoforecastFedpolicy tobethebestwaytoachievecontrolovermoney actionspartlybecausethepolicyprocessisbecom- creationasnecessarytoassurestabilityinthe ingmoretransparentthanitwasinthepast. purchasingpowerofmoney. SinceFebruary1994,theFOMChasannounced Withafiatmoneysystem,thecurrentvalue changesinthefedfundstargetthesamedaythat ofthedollardependsoncurrentpolicyandexpec- thedecisionsweremade.Asrecentlyasthelate tationsaboutallfuturepolicies.Confidencein 1980s,theFederalReservewasstillusingacom- thecentralbankisafoundationforconfidencein plexsignalingmethodofconductingopenmarket financialmarkets.Moderneconomiesthriveon operations(buyingandsellingsecurities)toinform theextensionofcredittopeoplewhoareyoung marketsaboutchangesinthefedfundsratetarget. andpeoplewhohavegoodideas.U.S.prosperity Thiscomplexmethodsometimestookseveral inthe1990s,extendingtothisday,hasbeen daystotransferinformationaboutpolicychanges. drivenbynewhigh-techenterprisesandthe Occasionally,thesignalswerecrossedandmar- applicationofnewtechnologytoexistingenter- ketsperceivedchangeswhentherewerenone. prises.Thenewenterpriseshavebeenfinanced Notonlywastheprocessinefficient,butalsoit throughprivateventurecapitalandthepublic tendedtofavorthebondmarketdealerswhohad capitalmarkets.Thesefirmswouldnothave aspecialarrangementtoparticipateintheexecu- beenabletoraisesuchalargeamountofcapital tionofopenmarketoperations.Announcingtarget iflendershadfearedthattheirprincipalwould changesthedaytheyaremademakesknowledge beconfiscatedthroughinflation. aboutpolicychangesimmediatelyknowntoall. IntheUnitedStates,andelsewhere,appreci- Anotherimportantfeatureofpost-1994Fed ationoftheimportanceofpricestabilitygrew practiceisthatalmostallpolicyactionscameat significantlyaspeoplesawtherealeffectsofinfla- regularlyscheduledmeetingsoftheFOMC.Before tionarypoliciesinthe1960sand1970s.This 1994,theFedchangedtheintendedratemore changeinbeliefssimultaneouslyincreasedpres- oftenbetweenregularmeetingsthanatregular sureontheFederalReservetoachievesustained meetings.Clearly,before1994,themarketwas lowinflationandincreasedthedeterminationof almostalwaystakenbysurprisebyFedpolicy policymakerstoachievethatgoal. 7 MONETARYPOLICYANDINFLATION Figure 4 CPI Inflation and Short-Term Inflation Expectations Figure4showstheCPIinflationrateandthe 1998-2000firstbroughtdownandthenincreased expectedinflationrateaccordingtotheMichigan measuredinflationwithouthavingmucheffect surveyfrom1956tothepresent.Thedataare onexpectedinflation. quarterly,andtheinflationrateshownistheper- One-yearaheadinflationexpectationsare centagechangeintheCPIoverthesamequarter inadequatetofullyexploretheissueofmarket thepreviousyear.Theexpectedinflationrateis confidenceinmonetarypolicy,butaretheonly theraterespondentssaidtheyexpectedoverthe surveyevidenceavailablebacktothe1950s.The nextyear. Michigansurveystartedtoaskabout5-10year Theactualinflationraterosealmostevery inflationexpectationsin1979,andthosedata yearfrom1965to1980.Inretrospect,troublewas areshowninFigure5.Asanaside,judgingfrom alreadybrewingin1964.Althoughtheactual thebehavioroflong-terminterestrates,market inflationratein1964overthecorresponding participantsinitiallyviewedtheinflationofthe quarterof1963wasinthe1to2percentrange, late1960sandearly1970sastemporary,butby surveyrespondentsexpectedtheinflationrateto thelate1970slong-terminflationexpectations rise,ascanbeseenbythefactthattheexpected rosedramatically.ConfidenceinU.S.pricesta- rateinFigure4liesabovetheactualratein1964. bilityreallydiderodesignificantlyafter1976. Theactualratedidriseafter1964,andfromthat However,aspolicysucceededinloweringand pointthroughtheearly1980stheactualand stabilizinginflationafter1980,long-terminflation expectedratesmovedverymuchtogether. expectationsfellandnowhavereachedthelowest Expectedinflationledactualinflationdown levelsobservedsincetheearly1960s. in1982,andafter1983expectedinflationwas Lowinflationforecastsoverlonghorizons somewhatmorestablethanactualinflation.The reflectconfidencethattheFedwillbesuccessful marketunderstoodthatsomeofthefluctuations inadjustinginterestratesintimelyfashionas inactualinflationweretransitory,anddidnot requiredtoyieldlowinflationontheaverage. justifychangingviewsonlikelyfutureinflation. Withlowinflationonaverage,thefederalfunds Thecollapseinoilpricesin1986reducedactual targetwillonaverageremainrelativelylow inflationforatime,buthadlittleeffectonexpected becausetherewillbenoinflationpremiumbid inflation.Similarly,fluctuationsinoilpricesin intointerestrates.TheFedcandirectlycontrol 8 ConfidenceandCentralBanking Figure 5 CPI Inflation and Long-Term Inflation Expectations onlytheovernightinterestrate.Thus,arelatively achievinglowandstableinflationisobviously low25-yearbondratereflectsconfidencethat important.Soalsoistheinstitutionalstructure theFedwillkeepinflationundercontrol.That oftheFederalReserveSystem,whichinsulates confidencespringsfromthemarket’sunderstand- itfromday-to-daypoliticalpressures.Attitudes ingofwhattheFedwilldowiththeone-dayrate, withintheSystem,thegovernment,andthe onaverage,overthenext25years.Peoplein generalpublicaresurelyimportant.Clearly,the marketsunderstandverywellthatitmaybenec- subjectisacomplexoneandbeyondthescope essarytoraisethefedfundsrateaggressivelyin ofthislecture. theshort-term,toensurethatitremainslowover TheelementofconfidenceI’veconcentrated thelong-term. on—onethatIbelieveisinsufficientlyappreci- ated—isthatthebetterthemarketunderstands theday-to-dayoperationofmonetarypolicy,the SHORT-RUN POLICY AND moreconfidentthemarketwillbethattheFedis LONG-RUN CONFIDENCE ontherightcourseforthelongrun.Since1994, themarkethasquiteaccuratelypredictedFed Asalreadyemphasized,theFederalReserve policyactions,indicatingthatthemarketunder- implementspolicythroughopenmarketopera- standswhattheFedisdoing.Themarketandthe tionsdesignedtokeeptheovernightfederalfunds Fedstudyincomingdataand,moregenerally, rateclosetothetargetratesetbytheFOMC.Even informationofallsortsandarriveatasimilar iftheFedweretoimplementpolicyinsomeother way,thereisnothingtoguaranteethatfuture assessmentofwhattheinformationmeansfor policywillbeconsistentwithsustainedlow theappropriatesettingofmonetarypolicy. inflation.Atanygiventime,successinkeeping Confidenceinanyorganizationistainted inflationlowrequiresmarketexpectationsthat wheneversomepartofitsactivitiescomesunder inflationwillremainlow—themarketmusthave question.ThefactthatFederalReservepolicy confidencethatthecentralbankwilldoitsjob weekbyweekissystematicandpredictable notjusttodaybutinthefutureaswell. inspiresconfidenceinthelargerissueofFed Wheredoesconfidenceinlong-runU.S. policyoverthelongrun.Ibelievethatthisdeeper pricestabilitycomefrom?Sustainedsuccessin long-runconfidencehascontributedtothedura- 9 MONETARYPOLICYANDINFLATION bilityofthecurrenteconomicexpansionandthe meeting.ThatisthesameprocessIgothrough increaseinproductivitygrowththathasgenerated myself,changingmyviewbitbybitasnewinfor- suchremarkablegrowthinGDPoverthelastfive mationarrives.AtthetimeofanFOMCmeeting, years. Icollatealltheinformation,includingtheexpert Thereisamystery,however.TheFOMCdoes Fedstaffanalysis,andsettleonatentativeposi- notfollowawell-specifiedmonetaryrulethat tiongoingintothemeeting.Thatpositionissub- canbewrittendownasanequationorformula. jecttochange,dependingontheforceofthe HowisitthatthemarketandtheFedcansocon- argumentsmycolleaguesmakeduringthecourse sistentlyagreeontheinterpretationofnewinfor- ofthemeeting. mationanditssignificanceforpolicyactions,or Thegoalofthepolicyactionsistoachieve lackthereof?Idon’tknowtheanswertothis lowandstableinflationfortheUnitedStates question.Findingtheanswermaybeimportant overthelongrun.TheFedcandolittlethatis forcarryingintothefuturethemarket’scurrent constructiveaboutshort-runfluctuationsinthe successinforecastingFedpolicyactions.Ifwe rateofinflation,butisresponsibleforthelong- canformalizewhattheFeddoes,itshouldbe runoutcome.Themarketunderstandsthepolicy possibletofurtherimprovetransparencyand objectiveandthereforecanjudgewhatpolicy accuracyofcommunicationwiththemarketin actionsarerequiredtoachievethegoal,given thefuture.Assuccessfulasmonetarypolicyhas theever-changingeconomicenvironment.Inthe beeninrecentyears,thereisstillamajoragenda researchthatRascheandIhaveconducted,most fortheFederalReserveandforscholarsofmone- largechangesinratesinthefedfundsfutures tarypolicyinassuringthatthesuccesscontinues. marketmakegoodsensegiventhenatureofthe newinformationthatapparentlydrivesthese changes. CONCLUDING THOUGHTS ThisconvergenceofFedandmarketopinion aboutwhatneedstobedoneisarelativelynew Oneofmythemestonighthasbeentheaccu- development.Althoughtheconvergenceisstill racywithwhichthemarkettodaycanforecast somewhatincomplete,itsimportanceforasuc- Fedpolicyactions.Howisthemarketsosuccess- cessfulmonetarypolicyshouldnotbeunderes- ful?Themarkethasanexcellentunderstanding timated.Imyselfcontinuetoworktobetter oftheprocessbywhichtheFedreachesitspolicy understandhowtheFedmightfurtherimprove decisions.ThatunderstandinginturnreflectsFed itscommunicationwiththemarkets.Thetaskis effortstobemoretransparentandmoresystematic. notaseasyasitmightseem,giventhecomplexity Forthemostpart,theFedandthemarketread oftheeconomicsandtheshort-runfocusofmany theflowofnewinformationthesameway.As marketparticipantsandpressrepresentatives. informationarrives,themarketchangestheproba- Butthatisasubjectforanotherday. bilityitassignstoFedactionatitsnextpolicy 10

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APA

William Poole (2000, October 13). Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/speech_20001014_poole

BibTeX

@misc{wtfs_speech_20001014_poole,
  author = {William Poole},
  title = {Speech},
  year = {2000},
  month = {Oct},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/speech_20001014_poole},
  note = {Retrieved via When the Fed Speaks corpus}
}