speeches · November 29, 2000

Speech

William Poole · President

How Well Do the Markets Understand Fed Policy? CenterforFinancialStudies Frankfurt,Germany November30,2000 I’m going to discuss a topic tonight that monetarypolicybody,implementsitsmonetary has been a research interest of mine for a policybysettingatargetlevelforthefederalfunds long time. Over the years, I have puzzled interestrateintheovernightmarketforbank over what to make of market reactions to reserves.TheFedcallsthistargetthe“intended news of Federal Reserve policy actions and eco- rate.”Giventhismodeofoperation,theeffects nomic data releases that might logically have ofmonetarypolicyworkprimarilythroughmar- implications for Fed actions. Since coming to ketexpectationsoffuturemonetarypolicy the St. Louis Fed in March 1998, my views have actions,becausethoseexpectationsdetermine coalesced into a research program, which I am longer-terminterestratesthataffecteconomic pursuing with bank colleagues. In fact, given all decisionsbyfirmsandhouseholds.Thus,the I have to do, they do most of the work, as you accuracyofmarketforecastsoffuturepolicy might expect. In this lecture, I’ll rely heavily on actionsisattheheartofthetransmissionof a paper I wrote jointly with Robert H. Rasche, monetarypolicytotheeconomy.Expectations director of research at the St. Louis Fed. The aboutfuturemonetarypolicy,inturn,dependon paper,entitled“PerfectingtheMarket’sKnowledge expectationsabouteventsandnewinformation ofMonetaryPolicy,”isavailableintheworking thatmayleadtheFedtoaltertheintendedrate. papers section of the St. Louis Fed web site; it NowlookatFigure1,whichreportsdaily will be published in the Journal of Financial datafromthefuturesmarketforfederalfunds. Services Research. Thefuturesinterestrateshownhereisthemar- Beforeproceeding,Iwanttoemphasizethat ket’sbestguessabouttheaveragefederalfunds theviewsIexpressherearemineanddonot rateforJune2000.Thefigurealsoshowsthelevel necessarilyreflectofficialpositionsoftheFederal oftheFed’stargetforthefederalfundsrate.On ReserveSystem.IespeciallythankmySt.Louis May16,theFOMCraisedtheintendedratefrom Fedcolleagueswhohaveprovidedextensive 6to6½percent.Thisfigureshowstheinterest assistanceinpreparingseverallecturesonvarious ratefromtradinginthefuturesmarketforthe30 aspectsoftheissueathand.However,Iretain daysbeforeandthe30daysafterthemeeting. fullresponsibilityforerrors. Theinterestingthingaboutthisfigureisthe accuracyofthemarket’sforecastdespitethefact thataFedpolicyactiontochangetheintended FORECASTING FED POLICY rateby50basispointsisarareevent.Thefirst DECISIONS tradingdayshownonthefigureisApril4.On Let’sbeginbylookingatsomerecentevents thisday,theintendedratewas6percent.The infinancialmarkets.I’llexaminetheseeventsby Junefederalfundsfuturescontractpricereflected usingseveralfigures,whichappearattheendof amarketexpectationthattheaveragefederalfunds thetextandinahandouteveryoneshouldhave. rateinJunewouldbe6¼percent.WhentheFed AsIthinkeveryonehereknows,theFederal changestheintendedrate,thechangeisusually OpenMarketCommittee(FOMC),theFed’smain 25basispoints,andthatiswhatthefuturesmarket 1 MONETARYPOLICYANDINFLATION Figure 1 Fed Funds Futures and the Fed’s Interest Rate Target wasexpecting.TheJunefuturesratewassteady theintendedrate,ornotchangeit,andineach untilthelastweekofApril,whenitjumpedpretty casethemarketmightcorrectlyforecasttheFed’s quicklyinacoupleofdays.Thenitcontinuedto decision,ornotforecastcorrectly. riseduringthenextfewweeks,graduallyincreas- Figure2containsamatrixofactualexamples ingto6½percent.OnMay16,theFOMCvoted foreachoutcomefromthefederalfundsfutures toraisetheintendedrateto6½percent.Sinceit market.Itispossiblethatthemarketanticipates isunlikelythattheFedwouldraisethetarget thepolicydecisionorthatitdoesnot.Thetwo betweentheFOMCmeetings—thenextmeeting figuresontheleftsideofFigure2showexamples washeldonJune27and28—byMay15the wherethepolicydecisionwascorrectlyantici- marketperfectlypredictedwhattheFOMC pated.Thetwoontherightshowexampleswhere woulddoatitsmeetingthenextday. itwasnot.Let’slookatthesecasesalittlefurther. Whatdowemakeofthissituationinwhich Theupper-leftpanelofFigure2showstrading themarketcorrectlyforecastswhattheFedis inthefuturescontractforSeptember1990and goingtodo?IstheFedjustfollowingthemarket? theFOMCmeetingheldAugust16,1990.Inthis IstheFedleakingtothemarketwhatitintendsto case,thefuturesmarketexpectedarelatively do?Isitagoodthingthatthemarketcanpredict large(50basispoint)increaseintheintended Fedactions?Toanswerthesequestions,ithelps federalfundsrate,andtheFOMCraisedtherate toconsidertherelationshipbetweenthefutures 50basispoints.Thiscaseisliketheoneexamined marketandFedpolicyactionsinmoredetail. inFigure1. Theupper-rightpanelofFigure2shows tradinginthefuturescontractforJanuary1991 FOUR POSSIBLE SCENARIOS andtheFOMCmeetingheldDecember18,1990. Figure1illustratesthesituationinwhichthe Beforethemeeting,themarketswerenotantici- marketcorrectlyforecastsaFeddecisiontochange patingthattheFOMCwouldreducetheintended theintendedrate.Infact,therearefourpossible rate;theratefortheJanuaryfuturescontractdid combinationstoconsider.TheFedmightchange notfalluntilaftertheFOMCacted.Infact,during 2 HowWellDotheMarketsUnderstandFedPolicy? Figure 2 Four Possible Scenarios thelifeofthiscontract,theFOMCreducedthe dictionsofFedpolicyimproveddramaticallyin federalfundstargetthreetimes,andeachchange 1994.Second,mostofthechangesinthefederal appearstohavesurprisedthemarket. fundsfuturesratesaredrivenbyeconomicnews ThetwopanelsinthebottomhalfofFigure2 suchasthemonthlyemploymentreportandthe showexampleswheretheFOMC’sdecisionwas inflationdata.Arelativelysmallpartofthe toleavetheintendedrateunchanged.Thebottom- changesinthefuturesratescomesondaysFed leftpanelshowstradinginthefuturescontractfor officialsgivespeechesortestimony.Although June1995andtheFOMCmeetingheldMay23, RascheandIdidnotinvestigatetheissueofleaks 1995.Inthiscase,themarketsexpectednochange inourresearch,Iamconvincedthatleaksare inthefederalfundstargetandtheFOMCleftthe extremelyrare.Iknowofonlyoneexampleofa targetunchanged. leaksinceIarrivedattheSt.LouisFed—itreceived Finally,thebottom-rightpanelofFigure2 attentioninthepressinthespringof1998—and showstradinginthefederalfundsfuturescontract itonlyindirectlyconcernedtheprobablefuture forAugust1994andtheFOMCmeetingheld settingoftheintendedfundsrateanyway. July6,1994.Beforethemeeting,themarketswere anticipatingalargeincreaseinthetargetrate,but theFeddidnotchangetherateatitsJulymeeting. UNDERSTANDING MARKET However,inthiscasethefuturesratedidnot SUCCESS IN FORECASTING FED changemuchafterthemeeting;themarketwas POLICY ACTIONS stillexpectingtheFedtoact,whichiteventually didatitsmeetingofAugust16,1994. I’mnowgoingtoillustratethekeyissues Beforegoinganyfurther,letmemention concerningmarketsuccess,orlackthereof,in brieflyafewgeneralfindingsfrommyresearch forecastingFedactionsbyanalyzingmoreclosely onthissubject.First,theaccuracyofmarketpre- thecasediscussedinFigure1.Let’sputasidethe 3 MONETARYPOLICYANDINFLATION Figure 3 June Contract for Fed Funds and Economic News relativelyinfrequentcasesinwhichspeechesor federalfundstarget,whichstoodat5½percent testimonybyFedofficialsseemtotelegraphFed onJanuary24;theFOMCraisedtheintendedrate intentions.AndIalsowanttoputasidethe to5¾percentatitsfirstmeetingoftheyearon hypothesisthattheFedissimplyfollowingthe February1-2.TheFOMCraisedthetargetagain, market,becauseI’mconvincedfrommyown byanother25basispoints,atitsmeetingon observationoftheprocessthatthishypothesisis March21.AswealreadysawinFigure1,the nottrue. final,50-basis-pointincreasecameonMay16. IfthemarketcanpredictFedpolicyactions TheopeningpriceofthecontractonJanuary quiteconsistently,thenFedbehaviormustbe 24impliedaJunefederalfundsrateof6.14per- systematicandregularenoughthatthemarket cent.Privateforecasterswereexpectingsome canmakeaccuratepredictions.Thus,theability slowingintheeconomy.Forexample,theJanuary ofthemarkettopredictFedpolicyactionsmeans BlueChipconsensusforecastwasfor3.0percent thatthemarketunderstandstheFed’sobjectives realGDPgrowthin2000:Q1and2.9percentfor andtheFedandthemarketsarereadingtheflow theyear.Theupwardtrendininflationthathad ofincominginformationthesameway.Inthis occurredin1999wasexpectedtocontinuein situation,Fedpolicyadjustmentswillnottake 2000.ThebestwaytointerprettheJunefederal marketsbysurprise. fundsfuturesrateof6.14percentonJanuary24 NowlookatFigure3.Thisfigureprovidesa isthatmarketparticipantsplacedaprobabilitya moredetailedexaminationoftradingintheJune bitabove0.5thattheFedwouldraisetheintended 2000federalfundsfuturescontractfromtheinitial rateby25basispointsandaprobabilityabit tradeonJanuary24,2000,tomaturityonJune30, below0.5thattheFedwouldleavetheintended 2000.Thefigurealsoincludesthehistoryofthe rateunchanged. 4 HowWellDotheMarketsUnderstandFedPolicy? Figure3includesverticallinesondayswhen thatthisincreasewaswellanticipatedbythe therewererelativelylargechangesintheinterest market.AscanbeseeninFigure3,atthispoint rateontheJunefuturescontract.Thethreshold thefederalfundsfuturesrateforJunewas6.24 I’veusedfordefininga“relativelylarge”change percent,indicatingthatthemarketexpected was±5basispoints.Duringthelifeofthiscontract, another25basispointincreaseattheMayFOMC therewereeightdaysonwhichtheabsolute meeting. changewas5basispointsorlarger.Thesedays Duringthethirdepisode,thefederalfunds aresortedintofourepisodes. futuresratefell10pointsonApril4andthen ThefirstepisodeincludedaFridayanda bouncedbackup5pointsonApril5.Itisnot Monday,January28and31.OnFriday,January28, clearwhatwasthecauseoftheinitialdecline. thefederalfundsfuturesraterose9basispoints. Thestockmarkethadbeenveryvolatileon Onthatday,the1999fourthquarterGDPdata April4—theDowJonesindustrialsfellover500 werereleasedshowingthatrealGDPhadgrown pointsearlyinthedayandthenrecoveredto 5.8percentatanannualrate,wellabovemarket finishthedaydownonly57.OnApril5,theDow expectations.TheJanuaryBlueChipconsensus, fellanother131pointsbutGreenspangavea forexample,hadbeen4.5percent.Inflationalso speechthatleftmarketsbelievingtheFedwould cameinhigherthanexpected—2.0versus1.6 liftthefederalfundstargetinMay.Attheendof percentatanannualrate.OnMonday,thestock thisepisode,thefederalfundsfuturesratefor marketsrosesharplyandthefederalfundsfutures Junewas6.28. rateroseanother5basispointsasmarketsdigested ThefinalepisodeoccurredonApril27with theunexpectedlygoodnewsabouteconomic thereleaseoftheadvanceGDPreportforthefirst growthandtheeffectthatitwashavingonfore- quarter.ThisreportshowedthatrealGDProseat castsforfutureinterestrates.Afterreceivingthis a5.4percentrateinthefirstquarter,withcon- information,themarketexpectedthefederalfunds sumerspendingjumping8.3percent,whichwas targetratetoaverage6.25percentinJune. thelargestquarterlyincreaseinmorethan17 Thesecondepisodeincludedariseandthen years.Laborcostsrose4.3percent,andconsumer adeclinesurroundingFedChairmanAlan pricescontinuedtorise.Itisinterestingtonote Greenspan’scongressionaltestimonyaboutmone- thatthenewswasexceptionalinoneway:The tarypolicy.Thefirstdayofhistestimonywason marketwassurprisedbybothhigherthanexpected February17.Thatdaythefederalfundsfutures realgrowthandhigherthanexpectedinflation. rateforJunerosesixbasispointsto6.27percent. Since1994,therehadbeenmanyupsidesurprises Thenextday,theWallStreetJournalreported, aboutrealGDPgrowth,buttheyhadtypically “GreenspansignaledthattheFedwillkeepboost- beenaccompaniedbylowerthanexpectedinfla- ingratesunlessbothconsumerspendingandthe tion.TheWallStreetJournalreportedthat,“The stockmarketquicklycooldown.” inflationnewsbooststheoddsthattheFedwill OnFebruary22,thefederalfundsfutures soonraiseinterestratesbyanaggressivehalfa ratefell6basispoints.Therewerenosignificant percentagepoint.”Thefederalfundsfutures economicdatareleased,andsowecannotlink marketseemedtoagreebecausetherateroseby thatdeclinetoanyparticularpieceofnewinfor- 11basispointsonthatdaytocloseat6.41.The mation.OnFebruary24,thefederalfundsfutures ratethenrosegraduallyto6.49ontheFriday ratefellanother5basispointsafterthegovern- beforetheMay16meeting. mentreportedthatordersfordurablegoodsfell I’verecountedthestoryoftheJune2000 1.3percentinJanuary,suggestingthattheecon- federalfundsfuturescontractinsomedetailto omymightbeslowingabit. illustrateageneralpoint.Howcanthemarket TheFOMCdidraisethefederalfundstarget participantssuccessfullypredictwhattheFOMC to6percentonMarch21;fromexaminingthe willdoatitsnextmeeting?Thatis,howdothey Aprilfederalfundsfuturescontract,weknow knowtheinterpretationtheFOMCwillplaceon 5 MONETARYPOLICYANDINFLATION theflowofincominginformation,suchasthat actionsbecausethetimingofthepolicydecisions recountedinthehistoryoftheJunefuturescon- betweenscheduledFOMCmeetingscouldnot tract?Partoftheansweristhatmarketparticipants bepredicted. carefullyfollowspeechesbyFOMCmembers, especiallythosebytheChairman,AlanGreenspan. ThetrackrecordofFOMCactionsisalsoobviously INTERPRETING MARKET important.UnderstandinghowtheFOMChas SUCCESS IN FORECASTING FED reactedtoinformationinthepastaidsinpredict- POLICY ACTIONS inghowtheCommitteewillrespondtosimilar informationinthefuture. I’llnowofferseveralpossibleinterpretations Marketparticipantspulltogetherothertypes ofmarketsuccessinforecastingFedpolicyactions. ofinformationaswell.Theyreceivetheminutes ThefirstisthattheFedissimplyfollowingthe oftheFOMCmeetingswithasixorseven-week market.Icandisposeofthisargumentontwo delay,afewdaysafterthenextscheduledmeet- levels.First,frommyownexperienceI’mcon- ing.Theseminutesrevealthetopicsdiscussed, vincedthatitisnottrue.Evenrecently,theFed summarizeviewsaboutthestateoftheeconomy, hassometimessurprisedthemarket.Aclearexam- anddescribethereasonsfordissentingvotes. pleisthefallof1998,whenthebondandstock Theminutesarethorough,whichprovidesan marketswereupsetfollowingtheRussiandefault importantvehicleforkeepingthemarketsand inAugust1998.Byreducingtheintendedfederal thepublicwellinformedaboutFedthinking. fundsrateonOctober15,betweenregularly MarketshavebeenabletoforecastFedpolicy scheduledmeetings,theFOMCledinterestrates actionspartlybecausethepolicyprocessisbecom- lower.Onatheoreticallevel,themarketequilib- ingmoretransparentthanitwasinthepast.Since riumisnotdefinedifthecentralbanksimply February1994,theFOMChasannouncedchanges followsthemarket,becausetheinterestrate inthefederalfundstargetthesamedaythatthe dependsontherateofinflation.Theinflation decisionsweremade.Asrecentlyasthelate1980s, rateisnotpinneddownatallifthecentralbank theFederalReservewasstillusingacomplex simplyfollowsthemarket. signalingmethodofconductingopenmarket AnotherpossibilityisthatFedofficials,espe- operationstoinformmarketsaboutchangesin ciallythechairman,signalthemarketastowhat thefederalfundsratetarget.Thiscomplexmethod thepolicydecisionwillbe.RascheandIinvesti- sometimestookseveraldaystotransferinforma- gatedalldailychangesintheone-monthahead tionaboutpolicychanges.Occasionally,thesig- federalfundsfuturescontractfromOctober1988, nalswerecrossedandmarketsperceivedchanges whenthemarketbegan,throughFebruaryofthis whentherewerenone.Notonlywastheprocess year.Weidentifiedalldailychangesof5basis inefficient,butalsoittendedtofavorthebond pointsormore,whichwedefinedas“large” marketdealerswhohadaspecialarrangementto changes,andexaminedthenewsarrivinginthe participateintheexecutionofopenmarketoper- marketonthosedays.Ofthe57largechanges,only ations.Announcingtargetchangesthedaythey 6occurredondayswhenspeechesortestimony aremademakesknowledgeaboutpolicychanges byFedofficialsmighthavebeenresponsible. immediatelyknowntoall. Twelveofthelargechangesoccurredinresponse Anotherimportantfeatureofpost-1994Fed toFedpolicyactions.On25occasions,press practiceisthatalmostallpolicyactionscameat speculationaboutpolicyactionswasevident; regularlyscheduledmeetingsoftheFOMC.Before for9ofthese,thespeculationseemedrelatedto 1994,theFedchangedtheintendedratemore releaseofemploymentdata. oftenbetweenregularmeetingsthanatregular Letmestepbacktosuggestanotherapproach meetings.Clearly,before1994,themarketwas tounderstandingmarketsuccessinforecasting almostalwaystakenbysurprisebyFedpolicy Fedpolicyactions.Consideraformalmathemati- 6 HowWellDotheMarketsUnderstandFedPolicy? calmodeloftheeconomy.Towritethemodel, fortheFederalReserveandforscholarsofmone- wehavetospecifyapolicyruleforthecentral tarypolicyinassuringthatthesuccesscontinues. bank.Theequationspecifyingthatrulecontains Thisframeworkalsoprovidesanagendafor thepolicyobjectiveorobjectivesandaprecise improvingpolicyoutcomesinthefuture.We descriptionofhowthecentralbanksetsitspolicy needmoreworkonhowthecentralbankcan instruments.Thepolicyrule,presumably,feeds bettercommunicateitspolicyintentionstothe backfromdataonrealizationsofexogenousand market.Perhapsmybiggestsinglesurprisesince endogenousvariables,orforecastsderivedfrom movingfromacademiatotheFederalReserveis thesevariables. howdifficultthistaskis.Theissuesareoften IntheUnitedStates,theFederalReserveand technicallycomplicated;aPh.D.ineconomics— themarketreceivenewdatafromgovernment orknowledgefromday-to-dayimmersionin statisticalreleasesatessentiallythesametime. monetarypolicyoveraspanofyears—really Thus,inthemathematicalmodeloftheeconomy, doeshelpinunderstandingtheissues.Members theonlyreasonableassumptionisthatthemarket ofthepressthroughwhomwemustcommuni- knowsthepolicyrule,havinglearneditfrom caterarelyhavethisbackground,andaverysmall experienceorsomeotherway,anddrawsthe fractionofthosereadingpressreportshasthis sameimplicationforpolicyactionsthecentral background. bankdoesfromthearrivalofnewinformation. Asanacademic,Icouldtalkintheabstract Torunamodelsimulation,wecouldsetthe aboutcentralbanktransparency,openness,and modelinmotionbyimposingstochasticshocks communicationofpolicyobjectivesandstrate- inthevariousequations.Whatwewouldobserve gies;asacentralbankerintenselyinterestedin inasimulationofthismodelisthatthemarket’s thesematters,Ifindthetaskextremelydifficult. forecastsofpolicyactions—forecastsembedded Itissoveryeasytosaythingsthataremisinter- inthetermstructureofinterestrates—wouldbe pretedthatsometimesitseemsthatthemost drivenbythearrivalofnewinformation.Letme effectivecommunicationistosaylittleandlet emphasizeagainthatthenewinformationthat policyactionsspeakforthemselves.However, affectsthemarketistheexactsameinformation intheendIbelieveitimportantthatwecentral thatcontrolsthepolicydecisions. bankersbemoreeffectiveincommunicating Themostreasonableinterpretationofthe whatwearedoingandwhy.Moderndemocra- Poole-Rascheempiricalfindings,Ibelieve,isthat ciesdemandopenness,andIthinkwejustmust intheUnitedStatestodaythemarketactsasifit respond. prettycloselyunderstandsthepolicymodelthe Feduses.Thereisamystery,however.TheFOMC doesnotfollowawell-specifiedmonetaryrule WHEN THE MARKETS AND THE thatcanbewrittendownasanequationorfor- CENTRAL BANK DISAGREE mula.HowisitthatthemarketandtheFedcanso consistentlyagreeontheinterpretationofnew I’vearguedthatinanidealworldthemarkets informationanditssignificanceforpolicyactions, andthecentralbankshouldarriveatthesame orlackthereof?Idon’tknowtheanswertothis conclusionsfromthesamedata.Whatiftheydo question.Findingtheanswermaybeimportant not? forcarryingintothefuturethemarket’scurrent Beforeaddressingthisquestion,letmeempha- successinforecastingFedpolicyactions.Ifwe sizethatIknowofnomodelsthatpointtothe canformalizewhattheFeddoes,itshouldbe desirabilityoftakingactionfortheexpresspur- possibletofurtherimprovetransparencyand poseofsurprisingthemarket.Therearesituations accuracyofcommunicationwiththemarketin inwhichrandomizingpolicyisclearlydesirable, thefuture.Assuccessfulasmonetarypolicyhas suchasintheroutingofarmoredtruckscarrying beeninrecentyears,thereisstillamajoragenda largeamountsofcurrency,orthetimingand 7 MONETARYPOLICYANDINFLATION commutingrouteofofficialswhomaybesubject latestdatarelease.SupposetheFedbelievesthat toterroristattacks.ButIknowofnosuchexam- achangeintheintendedrateisappropriate,but plesinthemonetarypolicyliterature. themarketisnotpredictingsuchachange?Given Whenthemarketsandthecentralbankdis- theverystronginflation-fightingcredibilitythe agree,implementingpolicyismoredifficult.By Fednowenjoys,myinstinctistowaitinsuch “disagreement”Imeanasituationinwhichthe circumstances.Itishardformetobelievethat market’sforecastofcentralbankpolicyaction thecourseoftheeconomywillbeaffecteddra- differsfromwhatthecentralbankiscontemplat- maticallyiftheFOMCactsataparticularmeeting ing.Disagreementmayindicatethatthemarket oratitsnextmeetingsixweekslater.Bywaiting, reallydoesnotunderstandwhatthecentralbank themarketsandtheFedcandigestadditional isdoing.AclearexamplefromU.S.experience data,whichmaymaketheappropriatecourseof isthe1979-82period.TheFederalReservewas actionmuchclearer. determinedtobringtherateofinflationdown TheFOMCalsoprovidesguidancetothe substantially,butpriorexperienceledthemarket marketaboutitsthinkingthroughitspressrelease todoubttheFed’sresolve.Restoringcredibility attheendofeverymeetingindicatingitsviewon onceitisimpairedisextremelydifficult.Inthe thebalanceofrisksintermsofhigherinflation early1980s,manymarketparticipantsexpected orhigherunemployment.Otherinformationin theinflationarypoliciestocontinue,andittook thepressreleaseandinitsmeetingminuteshelps perhapstwoyearsofdeterminedFedactionsto themarkettounderstandtheFed’spolicyoutlook. alterthatpresumption.Inthisperiod,theFed Ideally,theFedshoulddiscloseasmuchinfor- wasclearlycorrecttofalsifythemarket’sexpec- mationaspossiblesothatthemarketsandthe tationsastofuturemonetarypolicy. Fedwillinterpretincomingdatathesameway. Ifthecentralbankisgoingtofalsifymarket ButwhentheFedbelievesthatquickactionis expectations,itneedsaclearconceptionofits advisable,thenitshouldacttoleadthemarket. policyobjectivesandthebenefitsofhavingthe Explainingthereasoningbehindtheactionis marketslearnofthoseobjectives.Thecentral especiallyimportantinsuchcircumstances.The bankneedstothinkthroughtradeoffsamong clearestsuchcasesinceIcametotheSt.Louis objectivesandhowfaritiswillingtogoinpur- Fedwasinthefallof1998,asituationI’vealready suingitspolicyinoppositiontomarketexpecta- discussed. tions.Situationsdifferindifferentcountries;in Oneotherobservation:Attimes,acentral theUnitedStates,Ibelievethatthemedium-term bankmaywanttoactinanon-standardwayto inflationobjectiveisparamountandthatthe sendaclearmessagetothemarkets.Theclearest FederalReserveoughtnottradeoffthatobjective waytosendsuchamessageisbyimplementing againstothers.However,Ialsobelievethatwithin policyactionsthatareoutoftheordinary.And theinflationobjectiveitisperfectlyfeasiblefor thatrequiresthatmostpolicyactionsbe“ordinary.” theFedtousecorrectlytimedpolicyactionsto Thatis,abenefitofmakingpolicyasroutineand increasethestabilityofshort-runoutputand predictableaspossibleisthatthecentralbank employment.Tome,however,itisimportant establishesthecircumstancesthatenableitto thattheFednotoveremphasizeanyoftheshort- actdecisivelytoleadthemarketwhendoingso runobjectivesbecausedoingsomaycreate makesgoodsense. expectationsinthemarketthat,undercertain circumstances,willbeinconsistentwiththe inflationobjective.Whenacentralbankbegins CONCLUDING THOUGHTS tolosecredibilityontheinflationobjective,all sortsofotherthingsarelikelytogowrong. Mythemetonighthasbeentheaccuracy Moreroutinely,themarketandtheFedmay withwhichthemarkettodaycanforecastFed disagreewithrespecttotheinterpretationofthe policyactions.Howisthemarketsosuccessful? 8 HowWellDotheMarketsUnderstandFedPolicy? Themarkethasanexcellentunderstandingof theprocessbywhichtheFedreachesitspolicy decisions.Thatunderstandinginturnreflects Fedeffortstobemoretransparentandmoresys- tematic.Forthemostpart,theFedandthemarket readtheflowofnewinformationthesameway. Asinformationarrives,themarketchangesthe probabilityitassignstoFedactionatitsnext policymeeting.ThatisthesameprocessIgo throughmyself,changingmyviewbitbybitas newinformationarrives.AtthetimeofanFOMC meeting,Icollatealltheinformation,including theexpertFedstaffanalysis,andsettleonaten- tativepositiongoingintothemeeting.Thatposi- tionissubjecttochange,dependingontheforce oftheargumentsmycolleaguesmakeduringthe courseofthemeeting. Thegoalofthepolicyactionsistoachieve lowandstableinflationfortheUnitedStates overthelongrun.TheFedcandolittlethatis constructiveaboutshort-runfluctuationsinthe rateofinflationbutisresponsibleforthelong- runoutcome.Themarketunderstandsthepolicy objectiveandthereforecanjudgewhatpolicy actionsarerequiredtoachievethegoal,given theever-changingeconomicenvironment.Inthe researchthatRascheandIhaveconducted,most largechangesinratesinthefederalfundsfutures marketmakegoodsensegiventhenatureofthe newinformationthatapparentlydrivesthese changes. ThisconvergenceofFedandmarketopinion aboutwhatneedstobedoneisarelativelynew development.Althoughtheconvergenceisstill somewhatincomplete,itsimportanceforasuc- cessfulmonetarypolicyshouldnotbeunderesti- mated.Iamcontinuingtoworktounderstand howtheFedmightfurtherimproveitscommu- nicationwiththemarkets.Thetaskisnotaseasy asitmightseem,giventhecomplexityoftheeco- nomicsandtheshort-runfocusofmanymarket participantsandpressrepresentatives.Amore thoroughexaminationofpossiblestepstoimprove marketunderstandingfurtherisasubjectfor anotherday. 9

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APA

William Poole (2000, November 29). Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/speech_20001130_poole

BibTeX

@misc{wtfs_speech_20001130_poole,
  author = {William Poole},
  title = {Speech},
  year = {2000},
  month = {Nov},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/speech_20001130_poole},
  note = {Retrieved via When the Fed Speaks corpus}
}