speeches · April 5, 2004

Speech

William Poole · President

Inflation Signals and Inflation Noise UniversityofArkansasatLittleRock PeabodyHotel LittleRock,Arkansas April6,2004 The employment report for March, thisreference,soI’llhavetoexplainthatsome released last Friday and showing a jobs analystsarguedthatthedisappearanceof gain of 308,000 over February, was anchoviesfromthecoastofPeruin1972had certainly good news. Everyone hopes somethingtodowithrisinginflationin1973. that monthly reports over the rest of this year Today,however,economistsuniversallyaccept and for years to come will also bring good news thepropositionthatsustainedinflationordefla- on the employment front. tionis,inthewordsofMiltonFriedman,“every- Assumingthatemploymentgainscontinue, whereandalwaysamonetaryphenomenon.” marketfocuswillnaturallyshiftfromemployment TheexperienceoftheGreatInflationbrought toconcernsoverinflationrisks.Indeed,some hometothepublicandpolicymakersalikethe marketcommentaryalreadyhasshiftedinthat burdenthatinflationimposesonaneconomy. direction.Mypurposetodayistoprovidemy Intheabsenceofinstitutionsadaptedtoaninfla- perspectiveontheproblempolicymakersfacein tionaryenvironment,theefficiencyofmarket determiningwheninflationrisksarerising. pricestosignaltherelativescarcityofgoodsand Beforeproceeding,Iwanttoemphasizethat servicesisimpaired.Incomesandwealthareredis- theviewsIexpressherearemineanddonot tributedcapriciously,evenwhentheinflationis necessarilyreflectofficialpositionsoftheFederal partiallyforeseen,inataxsystemthatisnotfully ReserveSystem.Ithankmycolleaguesatthe indexed.Regulationsonnominalinterestrates, FederalReserveBankofSt.Louisfortheircom- suchasdepositceilingsandusurylaws,interact ments;RobertH.Rasche,seniorvicepresident withtheinflationratetodistortdemandincertain anddirectorofResearch,providedspecialassis- sectorssuchashousing.Somefinancialinstitu- tance.However,Iretainfullresponsibilityfor tions,suchasthethriftsthatspecializedinhous- errors. ingfinance,weredriventowardsextinction.Itis possible,thoughtheevidenceisnotconclusive, thatevenmodestsustainedinflationnegatively BACKGROUND impactstherateofgrowthoflaborproductivity. Inthefourdecadessincethebeginningofthe Centralbankersworld-widehavetakenthese GreatInflationofthe1960sand70s,economists lessonstoheart.Sincetheinitialinflationtarget- andcentralbankershaveacquiredamuchbetter ingexperimentbytheReserveBankofNew understandingofthesourceandconsequences Zealandin1990,thoughtatthetimetoberadical, ofinflation.WhentheGreatInflationbegan,it inflationtargetinghasbecomethestatedobjective wascommontociteoneoranotheridiosyncratic ofatleast11centralbanks,includingthoseof eventsasthedrivingforcebehindtheobserved developedanddevelopingcountries.Thesecen- changeinprices:OPEC,steelprices,anchovies tralbankspublisheitheranumericvalue,ora andforth.Anchovies?Fewtodaywillunderstand rangeofvalues,towhichtheycommitasaninfla- 1 MONETARYPOLICYANDINFLATION tionpolicyobjectiveoversometimehorizon.For expectationsinthemarket,theeconomyexperi- mostofthesecentralbanks,achievingtheinfla- encedasevererecessionin1981-82. tiontargetis,undernormalmarketconditions, Measuringinflationby12-monthchangesin thesinglepolicyobjective.Forthesepolicymak- theconsumerpriceindex(CPI),inflationfellfrom ers,theidea,embodiedintheoriginalPhillips apeakof13.3percentin1979to3.8percentin curveanalyses,thatitispossibletopermanently 1982,andremainedintheneighborhoodof4 trade-offalowerunemploymentrateorahigher percentintothemid1980s.Inflationroseabitin levelofrealoutputforahigherrateofinflation thelate1980s,andreached6.1percentin1990, hasbeenrelegatedtothetextbooksonthehistory inthefaceoftheoilshockthataccompanied ofeconomicthought. Iraq’sinvasionofKuwait. Othercentralbanks,includingtheFederal Intheearly1990s,theconsensuswasthat Reserve,havedeclinedtoquantifytheirinflation theeconomyhadnotreturnedtopricestability. objective.Nevertheless,most,ifnotallofthese Anysubstantialriskthatinflationmightrisewas institutionsacknowledgetheirprimaryrespon- clearlyundesirableandnecessitatedapolicy sibilitytoproducealowandstableinflation response.Butoverthecourseofthe1990s,infla- environment.InthecaseoftheFederalReserve, tionwasflattograduallyfalling,andwithfurther theFOMChasstatedasitspolicyobjectiveto declinesintheearlypartofthisdecademost achievepricestabilityinordertoachievemaxi- observersconcludedthatthebattleforpricesta- mumsustainableeconomicgrowth,therebyful- bilityhadbeenwon. fillingitsduallegislatedmandateunderthe Policydiscussionstodaymustconsidertwo- Humphrey-HawkinsAct. sidedoutcomes—theriskstopricestabilityare TheFOMChasneverdefined“pricestability” symmetric.Asignificantbreakoutofinflation numerically,butitscommitmenttopricestability aboveourcurrentsituationiscertainlynotdesir- isnotindoubt.Ihaveindicatedonseveralocca- able—noonewantstothrowawaythehard-earned sionsthatmyowninflationtargetiszero,properly accomplishmentsofthepast25years.However, measured.Becauseallourmeasuresofinflation asignificantdeclineininflationfromcurrentrates havesomeupwardbias,mydefinitionofprice maynotbedesirableeither—noonewantsto stabilityisconsistentwithasmallpositivemeas- replicatethedeflationaryexperiencesofthe1930s uredrateofinflation.Ourrecentinflationexpe- orJapan’sexperienceinthe1990s.Theconsensus rienceis,Ibelieve,agoodapproximationofprice oftheFOMC,asreflectedinthemostrecentpress stability. release,isthattheupsideanddownsiderisksto ThepolicyproblemfacedbytheFOMC,and inflationarealmostbalanced. manyothercentralbankers,todayissignificantly Whentheprimarybattleagainstinflation differentfromthat25yearsago.Bythelate1970s, startedin1979,therewasastrongcaseforpaying theinflationrateintheUnitedStateshadbecome greatattentiontotherateofmoneygrowthasa unacceptablyhigh—bothfortheFOMCandfor measureofthethrustofmonetarypolicy.Money thepublicingeneral.Therewasdisagreementin theeconomicsprofessionastowhetherthecosts growthisnotirrelevanttoassessinginflationrisks ofdisinflationarymonetarypolicywereworth today,buttheemphasishaschanged.Foravariety bearing,buttheFOMCconcludedthatamore ofreasons,andespeciallybecauseexpectations disciplinedmonetarypolicywasnecessary.The oflowinflationaresoentrenchedinthemarkets, decisivedatewasOctober6,1979,whenthe short-runmoneygrowthisaninadequateindica- FOMCdecidedtoadoptthe“NewOperating torformonetarypolicypurposes.Whatweneed Procedures.”Subsequently,theFOMCpermitted todoinsteadistoextractasbestwecanevidence thefederalfundsratetoexceed20percent.With ofpossibleinflationarypressuresfromavariety thetightermonetarypolicyandchanginginflation ofothersourcesofinformation. 2 InflationSignalsandInflationNoise TRANSITORY AND PERMANENT ofClevelandpublishessuchanindex.1The medianCPI,byconstruction,willexcludeany CHANGES IN PRICES CPIcomponentpriceindexthatishighlyvolatile Howcanwebestreadthe“news”intheprice intheshortrun,asthiscomponentinflationrate datathatbecomeavailableeverymonth?The willtypicallyappearinoneofthetailsofthe problemistouncoverinformationthatmight cross-sectiondispersionoftheinflationratesof indicatethatahigherrateofsustainedinflation theCPIcomponents. couldbeathand.TheFOMCshouldrespondto ImustconfessthatIamuncomfortablewith thesignalandnottothenoiseinthedata.Separat- arbitrarilydefinedfilters.Filteringoftransitory inginflationsignalsfrominflationnoiseisa shockswheretheshocksareunderstoodandcan seriouschallenge. beidentifiedisclearlyappropriate.Anexample Throughoutmostofthepost-WorldWarII istheincreaseintobaccopricesfollowingthe historyintheUnitedStates,inflationhasbeena legalsettlementwiththemajortobaccocompa- highlypersistentprocess.Neverthelessthereisa niesseveralyearsago.Itwaswellunderstood lotofrandommonth-to-monthvariationinthe thatthiswasaone-timeincreaseintobaccoprices measuredpriceindexes.Itisthisnon-systematic thatwouldfinancethefundsestablishedaspart variationthatwecall“noise.”Somehow,policy- ofthesettlement.Itwaspossibletoestimatethe makershavetolookthroughthe“noise”todiscern impactofthosepricechangesontheoverallCPI thesignalabouttheunderlyingtrendininflation andmosteconomistsfilteredthisimpactoutin inordertoformulateappropriatepolicyactions. ordertoassesstheinflationsignalatthetime. Thissignalextractionproblemistherationale Absentspecificinformationonwhichto forthedevelopmentofanumberofsupplemen- baseestimatesof“inflationnoise,”caremustbe tarymeasuresofinflation,beyondthebroad-based takentoassurethatthetechniquesusedtofilter priceindexescollectedbythegovernmentstatis- transitoryinflationarerobust.ThelateKarl ticalagencies.Inparticular,inadditiontotheCPI Brunnerusedtocriticizethe“uppertailtheory andpersonalconsumptionpriceindex,“core” ofinflation”—thatinflationiscausedbythe measuresofinflationthatexcludefoodandenergy increasesinthepricesofthoseitemsthathap- pricesareoftenhighlighted. penedtoberisingthefastestatanypointintime. InmonetarypolicyreportstoCongress,con- Ifthese“uppertail”ratesofinflationarefiltered gressionaltestimony,andpublicspeeches, outoftheinflationmeasure,thentherecanbe ChairmanGreenspanandothermembersofthe noinflation!Clearlyarbitraryfilteringcanbeused FOMChavefocusedonthecoremeasureofthe personalconsumptionpriceindex.Therationale todefineawaysubstantiveproblems.Ibelieve fortheconstructionofthecoremeasuresofinfla- thatadditionalresearchintodefiningand tionisnotthatfoodandenergyareunimportant extractinginflationtrendshasthepotentialto itemsofhouseholdconsumption.Thecoremeas- providevaluableinsightstomonetarypolicy- urescametoprominenceinthe1970swhenfood makers. andenergypriceswereextremelyvolatile.Under ThoughtheevidencesuggeststhatU.S.infla- thoseconditionsthecoreinflationmeasureslikely tioninthesecondhalfofthetwentiethcentury providedhelpfulfiltersthroughwhichtodiscern wasahighlypersistentprocess,itispossiblethat asignaloftheinflationtrend.Removingthese theobservedpersistencemayresultfromtheway componentsremovesasourceofshort-runnoise thatmonetarypolicywasimplemented.Unlike thatcanobscureunderlyingpricedevelopments. organizedassetmarkets,whereeconomictheories Anotherapproachtoidentifyingthesignalis suggestthatpricechangesshouldapproximate themedianCPIindex.TheFederalReserveBank arandomwalk,thereisnostrongtheoretical 1 Eachmonth’sreleasecanbefoundathttp://www.clevelandfed.org/research/data/mcpipr.htm. 3 MONETARYPOLICYANDINFLATION basisforhighlypersistentinflationrates.Recent theirrisingsteelcosts.Butmostothermanufac- researchsuggeststhatthepersistenceofinflation turersaretryingtopushsteel-pricejumpsofup intheU.S.hasdiminishedsincethemid1980s.2 to30percentto50percenttoothercompanies Economichistorianswhostudythegoldstandard alongthesupplychain,creatingtensionbetween periodconcludethatinflationinvariouscountries steelproducers,theirbiggestcustomersand wasmuchlesspersistentduringthatperiodthan numeroussmallersuppliersbetweenthem.”3 inthetwentiethcentury.Thelessonforthose Similarconcernsareoftenexpressedaboutthe tryingtoseparateinflationsignalsfrominflation depreciationofthedollaragainstthecurrencies noiseisthatthefiltersmaynotberobustto ofourmajortradingpartnersasasourceofCPI changesinmonetarypolicyregimes. inflationdirectlythroughthepriceofimported goodsorindirectlythroughinducedpricechanges ondomesticallyproducedgoodsthatcompete FORECASTING INFLATION withimports. Acriticalquestionforallcentralbankers,and Withoutquestion,individualfirmsoftendo theFOMCinparticularatthepresenttime,is passalongincreasesinpricesoftheirinputs. howinflationwillevolveinthenearfuture.Are Theissueiswhetherthisphenomenonisgeneral near-terminflationary(ordeflationary)pressures enoughtoexplainoverallinflation.Undoubtedly reallyquiescent?Theanswertothisquestion therearetimesduringwhichinflationshocks requiresaforecastingmodel,oralternativelya aretransmittedthroughsuchmechanisms.How- setofleadingindicatorsofinflation. eversuchforcesarenotuniversal.Automobile manufacturers,facedwithweakdemandinrecent Supply Chain Theories of Inflation yearshaveeffectivelycutretailpricesthrough incentiveprograms,discounts,rebatesandzero Oneviewthatcurrentlyisreceivingconsid- interestfinancing.Inthisenvironment,theyhave erableattentioniswhatIwilllabelthe“supply demandedandobtainedsubstantialpriceconces- chaintheoryofinflation.”Proponentsofthisview sionsfromtheirsuppliers.Inthiscase,downward characterizeinflationshocksasoriginatingin pricepressureshavebeentransmittedbackward rawmaterialsmarketsandsubsequentlytrans- throughthesupplychainstartingfromretailmar- mittedthroughintermediateproductstofinished ketsratherthanforwardfromcommoditymarkets. productsandfinallytoconsumerprices.From Backwardandforwardpricepressurescan thisperspective,inflationofcommodityprices isaleadingindicatorofPPIinflationwhichin existatthesametime.Theforwardpressures turnisaleadingindicatorofconsumerprice havebeenvisiblerecentlyinsomeindustries, inflation. butbackwardpressureshavebeenevidentfor Toproponentsofthesupplychainview,rapid severalyearsandseemlessnewsworthyatpresent. inflationinscrapsteelpricesandotherbasic Competitiveforcescanfrustrateeffortstopush commoditypricesinthepastsixmonthsisa increasedinputcostsupthesupplychain.The causeofsignificantconcern.Lastmonth,aWall WallStreetJournal,alsoinanarticlelastmonth, StreetJournalarticlereportedthatsomefirmsare reportedthatairlines,facingsubstantialincreases passingalongmaterialspriceincreases.“Indeed injetfuelprices“havemadeatleast12attempts ahandfulofcompanies—amongthemmakersof toboostairfaresinthepast2½monthsalone. mattressesandgymequipment—alreadyhasor Butmostoftheeffortshavefailedtostick,and arepreparingtoaskshopperstopaymoretocover increasinglythespoilerhasbeenoneormore 2 SeeT.CogleyandT.Sargent,“EvolvingPost-WorldWarIIU.S.InflationDynamics,”NBERMacroeconomicsAnnual,2001,pp.331-72;and A.LevinandJ.Piger,“IsInflationPersistenceIntrinsicinIndustrialCountries?”FederalReserveBankofSt.LouisWorkingPaper2002-023. 3 “CompaniesFightRisingSteelPrices,”WallStreetJournal,March8,2003,p.A3 4 InflationSignalsandInflationNoise budget-priceairlines,whichseeachanceinthe historyofCPIinflationitself.Thus,wesimply currentsqueezetoextendtheirmarketshares.”4 donotobservePPIinflationbeingpassedalong Inthiscasecompetitioninconsumermarketsis overtimeintotheCPItoanysignificantdegree. limitingthetransmissionofpricepressures Anotherapproachtotestingthesupply-chain throughthesupplychain. theoryofinflationistoexaminetherelationship Norareexchangeratedepreciationsneces- betweenvariousstagesofprocessinginthePPI. sarilyleadingindicatorsofpricechangesatthe Itturnsoutthatthelead/lagrelationshipforthe retaillevel.First,theU.S.remainsarelatively PPIstageofprocessingisevenweakerthanthat closedeconomywithalargefractionofthegoods forthePPIandCPI.Considerthestatisticalequa- andservicesconsumedhereproduceddomesti- tionexplainingPPIinflationforfinishedgoods cally.Second,researchindicatesthatthe“pass- usingthehistoryoffinishedgoodsinflationand through”ofexchangeratefluctuationsisnot thecurrentandprevious12monthsinflationof instantaneous,completeorconstant.5 thePPIindexforintermediateproducts.Theinter- Thereareseveralwaystotesttheideathat mediateproductsinflationaddslessthan1per- inflationatanearlierstageofprocessingfeedsinto centtothepredictivevalueoftheequation.Using inflationatalatterstage.Considerastatistical thesameapproachtoexplaintheinflationrate equationinwhichwetrytoexplainmonthlyCPI forthePPIforintermediateproducts,wefindthat inflationfromtheproducerpriceindex.The inflationinthePPIindexforcrudematerials consumerpriceindexisanindexofretailprices. addsonly4percenttothepredictivevalueof ThePPI,whichusedtobecalledthe“wholesale theequation. priceindex,”isanindexofpricesatanearlier Tosummarizethisdiscussion,althoughitmay stageofproduction.Theequationemploystwo seemlogicalthatincreasesincrudematerials groupsofexplanatoryvariables.Thefirstgroup prices,suchaspetroleum,wouldfeedforward consistsoftheprevious12monthsofCPIinflation. intosemifinishedgoodsandthenforwardagain WeincludetheCPIhistorybecausewewantto tofinishedgoods,infacttheinflationprocess determinethecontributionofthePPIoverand doesnotworkthisway.Dependingonconditions abovethecontributionoftheCPIhistoryitself. inindividualmarkets,sometimesinflationdoes Thesecondgroupconsistsofthecontemporane- feedforward,butsometimesitfeedsback.Wejust ousandprevious12monthsinflationofthePPI cannotreliablyconcludethattoday’smaterials priceindexforfinishedgoods. pricesinflationwillbetomorrow’sfinishedgoods Mostofthepredictivevalueisinthecontem- inflation. poraneousPPItermandthelaggedCPIinflation terms.ThefactthatthecontemporaneousCPI “Gap” Theories of Inflation andPPIinflationratesmovetogetherisaconse- quenceofinflationshocksthataffectpricesatall Anotherpopularframeworkinwhichto stagesofprocessingatthesametime.6Thetwelve analyzethetransmissionofinflationisthe“gap” laggedPPIvariablesaccountforonly11percent model.Variousimplementationsofthismodel ofthevarianceintheCPIinflationnotattributa- arerootedintheexpectations-augmentedPhillips bletothecontemporaneousPPIinflationandthe curve.Atypicalempiricalrepresentationofthis 4 “GrowingHeftPutsBudgetAirlinesinthePilot’sSeat,”WallStreetJournal,March29,2004,p.A1. 5 SeeP.K.GoldbergandM.M.Knetter,“GoodsPricesandExchangeRates:WhatHaveWeLearned?”JournalofEconomicLiterature,1997, 35(3),pp.1243-72;andP.S.PollardandC.C.Coughlin,“SizeMatters:AsymmetricExchangeRatePass-ThroughattheIndustryLevel,” FederalReserveBankofSt.LouisWorkingPaper2003-029C. 6 ThesimplecorrelationbetweenmonthlypercentagechangesofthePPIcrudematerialspriceindexandthePPIintermediateproductsprice indexis0.48;betweenpercentagechangesinthePPIintermediateproductspriceindexandthePPIfinishedproductspriceindexis0.74 andbetweenpercentagechangesinthePPIfinishedproductspriceindexandtheCPIis0.64overtheperiodMarch1948throughDecember 2003. 5 MONETARYPOLICYANDINFLATION frameworkpostulatesthattheinflationrateis inginflation.9Thefocusoftheiranalysiswas determinedbyinflationexpectations,current forecastsofinflationonatwelve-monthhorizon. andlaggedvaluesofa“gapmeasure,”current Theystartedtheiranalysiswith“conventional andlagged“supplyshocks”andundetermined specificationsofthePhillipscurve”thatrelated residualfactors.Intheseequations,acommon thechangeintheinflationratetopastvaluesof specificationofsupplyshocksincludeschanges anunemploymentgapmeasure,pastchangesof intherelativepricesoffoodandenergy,changes inflationandcurrentandpastvaluesofvarious inrelativeimportprices,and“productivity measuresof“supplyshocks”—thetypeofspeci- shocks.”“Gaps”typicallyaremeasuredasthe ficationdiscussedabove. differencebetweenrealGDPandameasureof StockandWatsonreachedseveral “potentialGDP”suchasthatconstructedbythe conclusions: CongressionalBudgetOffice,orbythedeviation 1.Inout-of-sampleforecaststhevarioussup- oftheunemploymentratefromanestimated plyshockmeasuresdidnotimprovethe equilibriumunemploymentrate.7 forecastingperformanceoftheirmodels; Thereareseveraltrickypartsofsuchanalyses; 2.whiletheestimatedrelationshipbetween oneisuncertaintyoverthelevelofpotentialGDP changesintheinflationrateandcurrent oroftheequilibriumunemploymentrate.Another andpastchangesininflationandunem- isobtainingareliablemeasure,orproxy,forthe ploymentfailstatisticaltestsforstability, expectedrateofinflation.Tomeasureexpected ineconomictermstherelationshipis inflation,oneoftwoapproachesisfrequently robust; applied.Thefirstistorepresentexpectedinflation 3.alternativemeasuresofrealeconomic asaweightedaverageofpastobservedratesof activitygeneratemoreaccurateforecasts inflation.Thealternativeapproachistoembed thandoequationswiththeunemployment thegapequationwithinamodeloftheentireecon- rate; omyandtoequateexpectationsoffutureinflation 4.theadditionofinterestratesandinterest withthemodelbasedforecastsofinflation.8 ratespreadsfailstoimprovetheforecasting RecentresearchattheFederalReserveBank performanceoftheestimatedmodel; ofSt.Louisshowsthatwithseveraldifferent 5.commoditypricesdonotimproveinflation modelsofexpectedinflation,includingthelagged forecasts;and inflationproxy,neitherthe“gap”termnorthe “supplyshock”termsaccountforthemajormove- 6.forecastsusingtheunemploymentrateout- mentsintherateofinflation.Theexpectedinfla- performsimplemodelsusingonlylagged tiontermtrumpstheotherfactorsasthemajor changesininflation,butthegaininfore- movingforceintheU.S.inflationhistory. castingaccuracyisrelativelysmall.Their analysisiswiderangingcoveringatotalof 168economicindicators.Anoverallassess- mentoftheirresultsisthatourabilityto FORECASTING INFLATION— deliversignificantlymoreaccurateforecasts EMPIRICAL EVIDENCE ofinflationbeyondthosethatcanbegen- In1999,JamesStockandMarkWatsonpub- eratedfromthehistoryofinflationitselfis lishedanexhaustivestudyofmodelsforforecast- quitelimited. 7 RobertJ.Gordonhasauthorednumerousstudiesapplyingthisframework. 8 R.Clarida,J.;GaliandM.Gertler,“TheScienceofMonetaryPolicy:ANewKeynesianPerspective,”JournalofEconomicLiterature, December1999,37(4),pp.1661-704. 9 J.H.StockandM.W.Watson,“ForecastingInflation,”JournalofMonetaryEconomics,1999,44,pp.293-335. 6 InflationSignalsandInflationNoise ANCHORING INFLATION inassetmarketswhen,forreasonsthatarenot wellunderstood,“bubbles”develop.Reality EXPECTATIONS chasesexpectations,whichinturnchasereality. Howisamonetarypolicymakertointerpret Eventsaredeterminedby“inflationarypsycholo- theaboveconclusions?Onepossiblereaction gies.”Pricesfollowexplosivepaths,eitherupward wouldbedespair—itisclosetoimpossibleto ordownward,foratime. discernthatnearfutureinflationwilldiffersys- Withinafewweeksofthedramaticchange tematicallyfromrecentpastinflationandsociety inpolicydirectionin1979,ChairmanVolcker willjusthavetolive,atleastforawhile,with testifiedbeforeCongressontheFOMC’snew recenthistory. operatingprocedures.Marketexpectationsplayed Ihaveanoptimisticalternativeinterpretation aprominentroleinhisthinking.“Theclearand oftheavailabledataandresearchresults.My presentdangerwasthatfailuretodealwithinfla- conclusionisthattheunfoldinginflationary tionandinflationaryexpectationswouldintime experienceismoststronglyanchoredbyhowthe producemore—notless—economicinstability, publicandfinancialmarketparticipantsexpect ultimatelywithhigherpricesandgreaterunem- inflationtoevolve.Welldesignedandarticulated ployment.Inthatsetting,thepriorityforpolicy policyundersuchconditionscanproducegreat wasdecisiveactiontodealwithinflationary outcomes.However,badlydesignedpolicies pressuresandtodefusethedangerousexpecta- underthesameconditionscanproducedisasters! tionalforcesthatwerejeopardizingtheorderly Ifmycharacterizationoftheimportanceof functionoffinancialandcommoditymarkets.”10 inflationaryexpectationsasadeterminantof inflationiscorrect,thenthereareimportantles- sonsformonetarypolicymakers.Inaneconomy CONCLUDING COMMENT thatworksthisway,itisessentialthatthecentral TheFOMCisunavoidablyinasituationof bankclearlyarticulateitsinflationobjectives,and havingtoapplyitsbestjudgmenttoavarietyof havethismessageregardedashighlycredible.If economicindicatorsofpossibleinflationarypres- acentralbankiscommittedtoalow-inflation sure.I’venotdiscussedtodayarangeofinforma- environment,andthatcommitmentiscredible, tiononinflationpressures,whichincludethe thenthegeneralpublicwillbelievefutureinfla- rateofproductivitygrowth,therateofincrease tionwillbelow.Underthesecircumstancesthe inunitlaborcosts,measuresofwageinflation economyhasastrongexternalnominalanchor. anecdotalreportsfrombusinessfirmsontheinfla- Thatnominalanchorgeneratesbehaviorbybuyers tionenvironmenttheysee.Instead,IhopeI’ve andsellersthatproduceslowandstablerealized convincedyouthatthereisnoregularandreli- inflation.Inrecentvernacular,atanygiventime ablerelationshipbetweeninflationinmaterials fewfirmsintheeconomyhaveany“pricing pricesorgoodsatanearlystageofprocessing power.” andretailpriceinflation. Inthistypeofeconomy,ifthecentralbank Ofcriticalimportancetomaintaininglow failstoarticulateaninflationobjective,orifit andstableinflationistheFOMC’scommitment lackscredibilitywiththepublicthatthestated toactaggressivelywheninflationriskschange, objectivewillbepursued,thenthedownsiderisk eitherupordown.Thatcommitmentanchors totheeconomyisenormous.Environmentsin marketexpectationsoflong-runinflation,and whichexpectationsarenotanchoredexternally makestheeconomymorerobusttoshort-run areinherentlyunstable.Weobservethisbehavior inflationshocks.Short-rundisturbancesdonot 10StatementbyPaulA.VolckerbeforetheSubcommitteesonDomesticMonetaryPolicyandonInternationalTrade,InvestmentandMonetary PolicyoftheCommitteeonBanking,FinanceandUrbanAffairs,U.S.HouseofRepresentatives,Nov.13,1979,FederalReserveBulletin, December,1979,p.959. 7 MONETARYPOLICYANDINFLATION automaticallygetbuiltintoinflation,whichhelps todampentheimpactsontheeconomyofinfla- tionshocks. ThisstableenvironmentalsohelpstheFOMC toavoidmistakes.Aboveall,wedonotwantto respondtoinflationnoise,whichwouldaddfur- therinstabilitytotheeconomy.Extractingthe inflationsignal,andrespondingtoit,iswhatwe trytodo. 8

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APA

William Poole (2004, April 5). Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/speech_20040406_poole

BibTeX

@misc{wtfs_speech_20040406_poole,
  author = {William Poole},
  title = {Speech},
  year = {2004},
  month = {Apr},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/speech_20040406_poole},
  note = {Retrieved via When the Fed Speaks corpus}
}