Speech

The Role of Monetary Policy in the Current Macroeconomic Environment PromotingEconomicGrowth:WhatMonetaryPolicyCanAndCannotDo NationalAssociationForBusinessEconomics43rdAnnualMeeting NewYork,NewYork September10,2001 In taking up the topic of this panel discus- intargetinganyrealvariable.Theeffectsonreal sion Promoting Economic Growth: What variables,suchasrealGDPgrowthandthe Monetary Policy Can and Cannot Do, I’m unemploymentrate,aretransitoryinnatureand tempted to refer you to Milton Friedman’s notverypredictable. 1967 presidential address to the American ThewayI’vestatedthispropositionisnot Economic Association, “The Role of Monetary quiteright,becausethereisampleevidenceto Policy,” and then sit down. But I won’t. What I supporttheviewthatthemonetaryinstability will do is organize my remarks around some of damageseconomicefficiencyandtherebyreduces the ideas noted in Friedman’s famous lecture. economicgrowth.Theconverseofthisobserva- Friedman’slectureisdirectlyrelevantto tionisthatmonetarystabilitypromoteshigher today’ssituationbecausetheeconomyissuffer- realgrowth.Moreover,timelypolicyactionscan ingfromarealdisturbanceintheformofsharp helptostabilizerealactivity—thatis,reducethe declineindemandforhigh-techequipment.To varianceofrealgrowth.Friedmanwasveryskep- whatextentcanmonetarypolicydealwiththis ticalthatactivistpolicycouldbesystematically realdisturbance?Whataretheopportunitiesand successful;heargued,oftenandeloquently,that whatarethedangers? thebestwearelikelytobeabletodoistoadopt Beforeproceeding,Iwanttoemphasizethat steadymoneygrowthasthepolicyrule.Ibelieve theviewsIexpressaremineanddonotnecessarily thatwehaveevidencefromU.S.monetarypolicy reflectofficialpositionsoftheFederalReserve since1982thatitispossibletoadjustpolicyina System.IthankmycolleaguesattheFederal stabilizingway.However,I’llsimplyassertand ReserveBankofSt.Louisfortheircomments, notarguethatpointhere. especiallyRobertRasche,directorofResearch, Myframeworkisthis.Firstandforemost,the andKevinKliesen,economistintheResearch centralbankmustmaintainacommitmenttolow Division.Iretainfullresponsibilityforerrors. andstableinflation.Ifthecentralbankdoesnot achievethatgoal,nooneelsecan.Ifinflation comesunstuck,allsortsofotherproblemswill REAL AND NOMINAL VARIABLES arise.Second,withintheconfinesofthegoalof Inhispresidentialaddress,Friedmanempha- lowinflation,thecentralbankhassomeflexibility sizedthatmonetarypolicyultimatelyonlyaffects toleanagainstfluctuationsinoutputandemploy- nominalvariables,suchasnominalinterestrates ment.However,thecentralbankoughtnotto andthepricelevel.Theeffectsmaybeseenin pursuethegoalofstabilizingeconomicactivity bothlevelformandratesofchange.Consequently, soaggressivelythatitrunsanysubstantialrisk thecentralbankcannotexpecttobesuccessful ofcompromisingthegoaloflowinflation. 1 MONETARYPOLICYANDINFLATION Finally,inleaningagainstfluctuationsin overtime.TheFedhasnowaytoaddressthe growthandemployment,thecentralbankought problemsofthisoranyotherspecificsectorof nottohavegoalsforlevelsoftheeconomy’s theeconomy. growthandunemploymentratesperse.Withina WhattheFedcando,atleasttosomeextent, widerange,wedon’tknowwhattheeconomy’s ispreventproblemsinspecificsectorsfrom equilibriumrateofgrowthis,andwhatrateof becominggeneralproblems.Thatisexactlyhow unemploymentwillclearthelabormarketinthe toviewmonetarypolicythisyear.Techinvest- longrun.Werunthebiggestrisksofamajormon- mentisdown,buthousinginvestmentandcon- etarypolicymistakeifweattempttotargetthe sumptionhavebeenmaintainedprettywell. levelsofrealvariables. Declininginterestrateshavecertainlyassisted insupportingaggregatedemand. Cushioningtheeffectsofthetechtumbleon THE TECH TUMBLE othersectorsisnomeanaccomplishment.Sofar, thingshavegonereasonablywellconsideringthe Growthintheaggregateeconomyhasslowed magnitudeofthedisturbance.Thispointisan toacrawlthisyear,butthecompositionof importantone.Giventhatmonetarypolicycannot demandhasbeenuneven.Residentialstructures determinethesectoralcompositionofoutput, investmenthasbeenprettystrong;consumption successmustbemeasurednotbythespeedand growth,thoughlowerthanlastyear,hasheldup extentofrevivalinhigh-techmanufacturingbut OK.Thetechsectorhastakenarealtumble. bytheperformanceoftheaggregateeconomy. Theallocationofproductionacrossvarious Nooneknowsforcertainwhethertheeconomy goodsisnotsomethingtheFederalReservecan canescapeanactualdeclineinrealGDP,butthe control.Acoupleofyearsago,whenmanyfarmers factthatwehavedonesotodateandthatmany intheSt.LouisFedDistrictweresufferingfrom adjustmentsarenowwellalongsuggeststhatwe drought,IoftenheardpleasthattheFedshould helpagriculturebyloweringinterestrates.My haveanexcellentchanceofdoingso.AndIsay answerwasalways,“theFedcannotmakethe thesethingsdespitethedismalemployment rainfall.”Today,withalltheexcesstelecom reportlastFriday. capacity,Iofferthesamesortofreply:theFed cannotmakecollegekidscallhomemoreoften. Theeconomyisworkingthroughaperiodof DEALING WITH UNCERTAINTY excessproductioncapacityininformationtech- Iftheeconomicboilerhasahole,withweak nologyandrelatedequipment.Someoftheadjust- techinvestmentdrainingawaysteampressure, mentwilltakecareofitselfasdemandrecovers itseemslogicaltoturnupthefiretokeepthe fromtemporaryweakness.Idonotmeantomini- pressurehighenoughthattheeconomiclocomo- mizetheproblembyusingtheword“temporary.” tivewheelskeepturning.Buthowmuchshould Thedeclineindemandhasbeenlargeandhas weturnupthefire?Isthetechholeintheboiler beenongoingforaboutayearnow.Wehaveno growingorhealingitself? guaranteethatdemandwillreboundquicklynext Howshouldpolicymakerscopewiththis quarterortheoneafter.Still,intime,investment uncertainty?OneofFriedman’simportant inhigh-techequipmentwillrecoverinthenormal courseofevents. points—thatknowledgeofhowmonetarypolicy Besidesthiscyclicaladjustment,however, affectstherealeconomyisincomplete—requires theremaybesomelonger-runadjustmentsthat theFedtobecautiousinrespondingtocurrent willeliminatecertainfirms.Wedon’tknowwhat developments.Ina1968statementthatringsas businessmodelswillworkintheInternetworld, truetodayasitdidthen,Friedmansaid:“We andwithanynewtechnologyittakesawhileto simplydonotknowenoughtobeabletorecog- figureoutwhatmodelsyieldreliableearnings nizeminordisturbanceswhentheyoccurorto 2 TheRoleofMonetaryPolicyintheCurrentMacroeconomicEnvironment beabletopredicteitherwhattheireffectswillbe Infact,becausemonetarypolicyworks withanyprecisionorwhatmonetarypolicyis throughthefinancialmarketsandbecausethese requiredtooffsettheireffects...Experiencesug- marketsareforwardlooking,marketanticipations geststhatthepathofwisdomistousemonetary ofpolicyactionsplayasignificantroleinthe policyexplicitlytooffsetotherdisturbancesonly effectivenessofmonetarypolicy.Whendiscussing whentheyoffera‘clearandpresentdanger’.” whatmonetarypolicycanandcannotdo,the Agreatsourceofstrengthinourcurrentsitu- issueofimprovingthepredictabilityofpolicyis ationisthatthemarket,asbestIcantell,holds ofgreatimportance.Onewaytoseethispointis rock-solidexpectationsthatthetrendrateofinfla- toimaginethatwehavealreadyidentifiedapol- tionwillremainlow,intheneighborhoodof icyrulethatiseffectiveinachievingpolicygoals whereithasbeeninrecentyears.Itseemsunlikely andhighlypredictable.Nowimaginedegrading thateconomicbehaviortodayandinthenear thatpolicybyaddingapurelyrandomcomponent futurewillbedrivenbyexpectationsofrising toit.Doingsonotonlywouldinduceinappropri- inflation.Still,thatfactdoesnotmeanthatinfla- atepolicysettingsbutalsowouldprovokeinap- tioncannotrise.Moreover,inflationcould—Iam propriatemarketresponsesbecausethemarket notforecastingthatitwill—creepupeventhough wouldhaveamoredifficulttimefiguringoutthe demandisnotrisingvigorously.Forexample, directionofpolicy.Workingtoreducethecom- we’veseensubstantialwageincreasesintheair- ponentofpolicythatappearstothemarkettobe lineindustry;ifairlinesaretobeprofitableover randomandunpredictablewill,therefore,pay time,theywillhavetorecoverthosecoststhrough significantdividends. somecombinationofproductivitygainsandprice Ifthemarketsareconfidentthatthecentral increases,eventhoughtraveldemandisnotcur- bankwilltakeappropriateaction,thetimingof rentlystrong. thatactionisnotcriticallyimportant.Bondyields TheFedmonitorstheeconomyverycarefully. begantofalllastyearlongbeforetheFedfirstcut TheBeigeBookprocessisavaluablesupplement theintendedfederalfundsrateinearlyJanuary totheformalstatisticalinformationwefollow. thisyear.Thebenefitsoflastyear’sdeclinesin Watchingcurrentdata,andgatheringanecdotal longratesinsupportingthisyear’shousingand information,helpsustoidentifychangesineco- consumerdurablesexpendituresareclear. nomicconditionsintimelyfashion.Nevertheless, Forthebondmarkettocontributeimportantly myownconvictionisthatweshouldnotrely toeconomicstabilization,asIbelieveitdoes, toomuchoncurrentobservationsonthestateof FederalReservepolicymustbepredictable. theeconomy—bothactivityandinflation—but MiltonFriedmanthoughtthatpredictability watchcarefullydirectmeasuresofthethrustof requiredsteadygrowthinmonetaryaggregates, monetarypolicyitself.Wehaveampleevidence butclearlythecurrentsystemhasalsoprovento fromhistorythattheeffectsofmonetarypolicy behighlypredictable.Idonotmeantoimplythat actionsarestretchedoutovertime,andthatthose short-terminterestratescanbepredictedlong effectsarenoteasytopredictfromcurrentprice inadvance,forratesshouldanddorespondto andproductiondata.Ibelievethatthereisinfor- eventsthatcannotthemselvesbepredicted.But mationinthemonetaryaggregatesonthethrust iftheFed’spolicyactionsinresponsetoevents ofmonetarypolicyandthatweignorethatinfor- ishighlypredictable,thenthemarketcanrespond mationatourperil. efficientlytothosesameevents.Further,tothe extentthatthemarketcanpredictcertainevents betterthantheFedcan,interestrateswillchange THE MARKET AS ALLY soonerthantheFedcouldchangethem. Economicpolicyofallsortsworksbetter Ourunderstandingofthisprocessisincom- whenitharnessesmarketforces,ratherthanfights plete,butIthinkwe’vemadealotofprogressin withthem.Monetarypolicyisnoexception. recentyears.Oneoftheimportantthingsthatthe 3 MONETARYPOLICYANDINFLATION FederalReservecandoistocontinuetoimprove theflowofinformationaboutwhatitisdoing andwhy.TheFedtookahighlyproductivestep inFebruary1994whenitbeganreleasingitspol- icydecisionpromptlyattheconclusionofeach FOMCmeeting.TheSt.LouisFedisdevotingits OctoberresearchconferencetotheissueofFed transparency,andI’mhopefulthatcontinuing researchonthistopicwillshednewlightonhow theFedcanimproveitscommunicationwiththe market. SUMMARY Tosummarizemyargument,monetarypolicy isaboveallresponsiblefortheeconomy’strend rateofinflation.Thatiseverycentralbank’scen- tralresponsibility. Successinkeepingtherateofinflationlow andstableyieldsmanydividends.Oneisthat marketexpectationsofinflationremainlowand changelittleovertime.Thatenvironmentprovides maximumscopeforthecentralbanktoadjust policytocushionrealdisturbances—toreduce thevarianceofrealgrowthandemployment. However,itisdangerousforpolicytoattemptto hitrealtargets;weknowthat,inthelongrun, monetarypolicydeterminesnominalandnot realmagnitudes. Intoday’seconomy,wedonotknowwhere theunemploymentratewillsettleaftertheecon- omy’sgrowthresumes,nordoweknowwhatthat growthratewillturnouttobe.Iamanoptimist onlong-rungrowthbutknowthatuncertainty overtherateisconsiderable.Forthatreason,set- tingmonetarypolicytoachieveaparticularrate ofgrowthishazardous. Finally,weshouldnotunderestimatethe importanceofthemarketsincontributingto economicstabilization.Themarketisinherently monetarypolicy’sfriend,andweshoulddoevery- thingpossibletoimprovemarketunderstanding ofthecourseofpolicy. 4

William Poole (2001, September 9). Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/speech_20010910_poole

@misc{wtfs_speech_20010910_poole,
  author = {William Poole},
  title = {Speech},
  year = {2001},
  month = {Sep},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/speech_20010910_poole},
  note = {Retrieved via When the Fed Speaks corpus}
}