Speech

Safeguarding Good Policy Practice “ReflectionsonMonetaryPolicy25YearsAfterOctober1979” FederalReserveBankofSt.Louis St.Louis,Missouri October8,2004 PublishedintheFederalReserveBankofSt.LouisReview,March/April2005,87(2,Part2),pp.303-06 Ican’t help recognizing an emotional note makeforhappyreadingtoday.Ihopethatwe inmyreactiontothisconference.Yesterday, neveragainseeFederalOpenMarketCommittee we enjoyed three superb scholarly papers. (FOMC)memberswiththatattitude.Policymakers Allan Meltzer’s paper left me depressed, neednotbeprofessionaleconomists,butthey and the Lindsey, Orphanides, Rasche paper left mustbeabletounderstandwhateconomistsbring me elated. Marvin Goodfriend’s paper left me tothetable. with hope for the future. Howdowesafeguardahighlevelofexpertise ButnowI’lltrytobeadispassionatesocial intheFOMCofthefuture?Thereisnowayto scientist.Thispanelinevitablyoverlapssomewhat ensurethattheappointmentprocesswillalways thepreviousoneonwhatwehavelearnedsince puttherightpeopleontheFOMC.ButIthinkwe October1979.Innosmallpart,whatwehave canhelptoguardagainstappointmenterrorsby learnedsinceOctober1979startswithwhatwe workingwithReserveBankdirectors,whochoose learnedfromtheGreatInflationandhowitwas ReserveBankpresidents,withCongress,and broughttoanend.Goingforward,weneedto withopinionleadersingeneral.Thoseofusin incorporateinpolicypracticebothsoundtheory leadershippositionstoday,andeveryoneelse andlessonsfromhistory. withmonetarypolicyexpertise,needtospend Iwillmakefivemajorpoints,noneofwhich timeinhelpingtoinstillinthegeneralpublica isnewbutallofwhichdeserveattentioninthe deeperunderstandingofmonetarypolicyrespon- contextofthisconference.First,goodscienceis sibilities.Weneedtodiscusswhatcharacteristics extraordinarilyimportant.Second,marketconfi- arenecessaryforpolicymakerstobesuccessful.I denceinthecentralbankisessentialforgood hopethatweneveragainhaveappointments monetarypolicy.Third,stabilityofthereal yieldingtheresultsofthe1930s,1960s,and1970s. economyrequirespricestability.Fourth,central Thelargestgapinmacroeconomicsisthe bankershaveanobligationtocommunicate weakunderstandingoftherelationshipbetween clearlywiththegeneralpublic.Fifth,weshould realandnominalvariables.Inourmodels,we notunderestimatetheroleofleadership. employaPhillips-curvetypeofrelationshipto modelinflation,orchangesintherateofinflation. Inourmodels,adepartureoftheactualrateof GOOD SCIENCE inflationfromtheexpectedratedependsona Theproblemsofthe1960sand1970swere currentandexpectedfuturerealgapmeasureof partly—nottotally,butpartly—theconsequence somesort.Isimplydistrustthismodel,onboth ofbadeconomics.AllanMeltzerhasdiscussed theoreticalandempiricalgrounds.Empirically,I thoseissues,andIdonotneedtorepeathisargu- don’tthinkitworksverywell,andtheoretically menthere. itoughtnottoworkverywell. InoteespeciallythatChairmanMartin’sdis- I’dlovetohearChairmanGreenspanoffera missalofeconomicsandeconomistsdoesnot systematicexpositionofhisenormoussuccess 1 MONETARYPOLICYANDINFLATION inforecastinginflationpressures.Mysenseof sayaboutthestrengthofsteelwhenbridgesfall whatIdo,whichIthinkisnotdissimilartowhat down.Similarly,thenoneconomistreallydoesn’t mostFOMCmembersdo,isattempttointuit careabouttherateofmoneygrowth.Ifitworks, futureinflationpressuresfromcurrentobserved fine,butstablemoneygrowthisnotasubstitute pressuresastheyshowupinbothpricechanges forpricestability.Ofcourse,anintermediatetarget andresourcepressures,orrealgaps,inindividual maybeoftransitionalimportanceinrestoring markets.Theapproachisnottotallywithout confidence,asthe1979-82experienceshows. theory;forexample,wagechangesareevaluated Restoringconfidencemayrequire—indeed,I inlightofexpectedproductivitytrends.Iattempt suspectinmostcasesdoesrequire—bearingalot tosortouttemporaryfrommorelastingwageand ofpaintodemonstratethatacentralbankisseri- pricechangesandattemptinformallytoconstruct ousaboutmeetingitsresponsibilities.Thereces- anappropriatelyweightedaverageofdisparate sionof1981-82issuchanevent.Themarketwants experienceinvarioussectors.Ilookcloselyat toseethecentralbankisabletobearpain,and dataoninflationexpectations,buttreatsuchdata thereasoningissimple.Ifyoucannotwithstand carefullybecauselonger-runexpectationsare alotofpain,whyshouldanyonebelieveyouare reallyavoteofconfidenceontheFedandnotan seriousgivenallthepressurestochangecourse? independentreadingoninflation. Technicalexplanationscanalwaysbeofferedto Iamextremelyuncomfortablewiththis explainachangeinpolicydirection,butifit approachandbelievethatitisaninvitationto appearsthattechnicalmumbojumboisanexcuse futuremistakes.Idon’tknowwhatbettertodo. fornotcompletingthejob,thenconfidencewill notberestored.Thus,achangeinpolicydirection willrequireafairlyunderstandableexplanation PUBLIC CONFIDENCE onceafairamountofpainhasbeenendured. Thelogicofpainseemsinescapable.Inflation Astandardfeatureofmonetaryanalysisin cannotfallpermanentlyunlessinflationexpecta- recentyearsisthatmarketconfidenceinthe tionscomedown.Expectationswillnotcome centralbankistremendouslyimportant.Retain- downintheabsenceofconfidencethatthecentral ingconfidencerequires,aboveall,successfulout- bankwillkeepinflationdowninthefuture.Confi- comes.Thereisnoadequatesubstituteforgood denceinthecentralbankwillnotbeobtained results.Themarketdoesnotrequireperfection— unlessthemarketbecomesconvincedthatthe peopledounderstandinbroadoutlinewhatthe centralbank,andthepoliticalsystemmoregen- centralbankcanandcannotdo.Peopleunder- erally,hastheinstitutionalstrengthtomaintain standthatsomesmallmistakesareinevitable. lowinflation.Therealtestofinstitutionalstrength Still,themarketwillsurelyloseconfidencefrom iscapacitytobearpain. mistakesoccurringyearafteryearafteryear. Therationalexpectationsargumentofcostless Onceconfidenceisgone,restoringitisincred- disinflationthroughrestorationofcredibilitynever iblycostly.ThatisoneoftheprimelessonsofU.S. appealedtome.In1979,givenwhattheFedhad experienceinthelate1970sandearly1980sand saidanddoneoverthepreceding15years,it experiencearoundtheworld.Torestoreconfi- wouldhavebeenirrationaltohavegrantedthe dence,itisnecessarytoachieve,oratleastmake Fedinstantcredibility. progresson,policyobjectivesofpricestability andfullemployment. Makingprogressonpolicyobjectivesisfar PRICE STABILITY AND REAL moreimportantthanhittinganintermediatetarget ECONOMIC STABILITY suchasasteady,moderaterateofmoneygrowth. Tothenoneconomist,intermediatetargetsare Mythirdpointisthatmaintainingpricesta- highlytechnicalincharacter.Iamnotanengineer, bilityisextraordinarilyimportantforstabilityof forexample,andreallydon’tcarewhatengineers therealeconomy.Theideathatwecantradeoff 2 SafeguardingGoodPolicyPractice employmentstabilityagainstinflationstabilityis Ihavenottriedtoresearchforaccuracy,isthat flawed.Idonotwanttodenythattheremaybe traditionalconcernswerenotstatedforcefully sometrade-offaroundtheedges,butthekeyregu- byarticulatedefendersofpricestabilitywithin larityisthatinstabilityofinflationandrealgrowth theFed. arepositivelycorrelated.Toleranceofhigherinfla- Centralbankerscaninfluencepublicdebates, tionisnotarecipeforcreatinghigheremploy- iftheytry.OneofthelessonsIdrawfromthe mentorimprovedemploymentstability,butjust GreatInflationisthatthoseofusinleadership thereverse.Thereasonisthatinflationinstabil- positionsintheFederalReservehaveanobliga- itycreatesmoreinstabilityininflationexpecta- tiontocommunicateactively.Ifwedonot,by tionsandwiderdispersionintheexpectedrate defaultweleavethedebatetoothers.Ithinkthat ofinflation. academicsareimportanttopublicdebatesprima- Greatervariabilityanddispersionofinflation rilythroughthelonger-runforceoftheirscholarly expectationsincreasesthemagnitudeofexpecta- contributions.Theseareallthatreallymatterin tionalerrorsandthereforeincreasesmisallocations thelongrun;intheshortrun,someacademics intherealeconomy.Moreover,anincreasein commandpublicattention,butnotverymany inflationtendstoreducethemarket’sconfidence andnotmuchattentionintheschemeofthings. inthecentralbank,which,inturn,makesitmore Pressattentionisconcentratedonpoliticians, difficultforthecentralbanktoadjustitspolicy office-holdersingeneral,andbusinessleaders tohelpstabilizetherealeconomy.Thispointwas whocontrollargeresources.FederalReserve office-holdersimmediatelyattractpressattention, demonstrateddramaticallyinthe1980-82period. bynatureoftheirpositions.AsaReserveBank GivenweakmarketconfidenceintheFederal president,Ihaveanopportunitytoreachanaudi- Reserve’swillingnesstocontrolinflation,theFed encefarlargerthanIeverhadasaprofessorat wasnotabletoswitchgearstowardalessrestric- BrownUniversity. tivepolicyasemploymentweakenedinthe1981 Thecommunicationsenvironmentisquite recession.Thecentralbankcouldnotswitchgears differenttodayfromtheearly1980s,whenthe becausedoingsorantheriskofundoingtentative Fedreleasedrelativelylittleinformation.Inthe progressinrestoringthemarket’sconfidencein interestoffulldisclosure,Iwasoneoftheskeptics thecentralbank. whentheFedabandonedreservetargetinginthe TheargumentsIhavejustofferedflowfrom latesummerof1982.MyfearwasthattheFed soundeconomics—theobservedpositivecorre- wouldembarkonceagainonapolicythatwould lationbetweeninflationinstabilityandemploy- permitinflationtorise.Asamonetaryeconomist, mentinstabilityiswhatweoughttoexpect. perhapsIknewtoomuch;IfoundtheFed’sexpla- nationforswitchingfromnonborrowed-reserves toborrowed-reservescontrolin1982anexample COMMUNICATION ofthetechnicalmumbojumboIreferredtoearlier. AllanMeltzerdiscussedtheintellectual Butthemarketboughttheargument,andthefact environmentthatmadetheGreatInflationpossi- thatmonetaristssuchasIweresuspiciouswas ble.Bythe1960s,traditionalcentralbankconcern irrelevant.Iwaswrong,andIamcertainlyhappy overinflationhadcometoberegardedasold thatIwaswrong. fashionedandtheneweconomicspromiseofan Still,thecurrentenvironmentofmuchgreater optimaltrade-offofmodestinflationtobuylower Fedopennesshasprobablyraisedthestandard unemploymenthadwonmanyconverts.Although ofwhatwillberequiredindebatesinthefuture. theFederalReserve,especiallytheBoardof IftheFedmakesmajormistakesandmustagain Governors,includedconverts,theFedalso embarkonacampaigntorestorecredibility,I includedleaderswhosharedtraditionalconcerns suspectthatitwillhavetopursueamoreopen aboutinflation.Mymemoryofthisperiod,which dialogwiththepublic. 3 MONETARYPOLICYANDINFLATION Inanyevent,safeguardinggoodpolicyprac- achievementsinthe1979-82period.Sayingthat ticefrompoliticalpressureswillrequireongoing isnotmeanttoimplyanegativecommentabout communicationwithCongress,marketprofes- hisachievementsinlateryears.Butcertainly sionals,leadingcitizens,andthegeneralpublic. 1979-82wasacriticalperiodinU.S.monetary Goodmonetarypolicywillbeeasier,andmore history.IknowthatPaulVolckerdidnotdothe effective,withwidespreadunderstandingofwhat jobalone—supportfromPresidentReaganwas constitutesgoodpolicy.Thattomeisoneofthe critical.Thatsaid,therewasnoguaranteethat clearlessonsoftheGreatInflation. PresidentCarterwouldappointPaulVolcker. Volckerwasalogical,butnotinevitable,appoint- ment.PresidentCartercouldinsteadhave LEADERSHIP appointedaChairmanwhowouldhavecontinued thepolicyofdrift.Theinflationratewouldhave Mylastpointconcernstheroleofleadership. continuedtorise,andthepainofunwindingthe ThisconferenceisacelebrationofPaulVolcker’s inflationwouldhavebeengreater. leadership. TheGreatInflationisunderstandable,but Centralbankleadershiprequiresattimesa wasnotunavoidable.Strongerleadershipby willingnesstopushhardenoughtogetthejob ChairmanMartinwouldhavecutshorttheearly done—andrecognitionofhowhardistoohard. developmentofinflation.ChairmanBurnscould Thecentralbankdoesnotwanttogetitselffired havestoppedit.Theintellectualandpolitical throughchangesinlaworappointmentsthat environmentofthe1960sand1970scertainlyhad underminethebank’sauthority.Pushinghard alottodowithmakingtheGreatInflationpossi- enoughbutnottoohardisobviouslyadiceyact ble.Still,theGreatInflationwasnotinevitable. attimes,requiringpoliticaljudgmentandacumen, Leadershipreallydoesmatter. butitisneverthelessonethatcentralbankleader- shipmustbeabletopulloffsuccessfully. Iappreciate,atamuchdeeperleveltoday thanIdidatthetime,theextentofPaulVolcker’s 4

William Poole (2004, October 7). Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/speech_20041008_poole

@misc{wtfs_speech_20041008_poole,
  author = {William Poole},
  title = {Speech},
  year = {2004},
  month = {Oct},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/speech_20041008_poole},
  note = {Retrieved via When the Fed Speaks corpus}
}