speeches · March 4, 2007
Speech
William Poole · President
Inflation, Financial Stability, and Economic Growth
GlobalInterdependenceCenter(GIC)AbroadinChileConference
KeynoteAddress
UniversidadAdolfoIbáñez
Santiago,Chile
March5,2007
The Federal Reserve Act as amended in cialstabilitywillbemoredifficult,ifnotimpos-
1977 directs the Federal Reserve to sible,toachieve.
pursue monetary policies to achieve I’lldiscussevidencefrombothrecentand
the goals of “maximum employment, not-so-recenthistorythatsupportmycontention
stable prices, and moderate long-term interest thatasoundmonetarypolicy—thatis,commit-
rates.”TheFederalReserveandallcentralbanks tedfirmlytolong-runpricestability—iscon-
have also long been expected to promote finan- ducivetofinancialstabilityandeconomic
cial stability. Since the 19th century, central growth.Someofthisevidenceisnotpretty—it
banks have been expected to serve as lender of showshowanunstablepricelevelcanwrecka
last resort to the banking system. financialsystemandharmtherealeconomy.
Thegoalsofmaximumsustainableemploy- Beforeproceeding,Iwanttoemphasizethat
mentandeconomicgrowth,stableprices,mod- theviewsIexpressherearemineanddonot
erateinterestrates,andfinancialstabilityaretoo necessarilyreflectofficialpositionsoftheFederal
oftenviewedasincompatiblewithoneanother. ReserveSystem.Ithankmycolleaguesatthe
Conventionalwisdomholds,forexample,thatif FederalReserveBankofSt.Louisfortheircom-
monetarypolicyistoofocusedoncontrolling
ments,especiallyDavidC.Wheelock,assistant
inflation,thenoutputandemploymentgrowth
vicepresidentintheResearchDivision,who
willlikelyfallbelowtheirpotentialandfinancial
providedspecialassistance.However,Iretain
marketswillbelessstablethantheyotherwise
fullresponsibilityforerrors.
couldbe.
Today,IwillelaborateonhowIseeinflation,
financialstabilityandeconomicgrowthfitting
SOUND MONETARY POLICY
togetherinacoherentframeworkformonetary
policy.Idonotsubscribetotheconventional I’llbeginbyoutliningtheessenceofsound
wisdom.Neithereventsnoreconomictheory monetarypolicyandwhyIbelievethatsound
supportthenotionthatamonetarypolicydirected policyisaprerequisiteforfinancialstabilityand
towardpricestabilitywillresultinalessstable maximumeconomicgrowth.Thefoundationof
financialsystemoranunderperformingreal asoundmonetarypolicyislong-runpricestabil-
economy.Rather,inmyview,pricestability, ity.By“pricestability”Imeanalowandstable
financialstabilityandeconomicgrowthare rateofinflation.Ibelievethattheoptimalrateof
mutuallyconsistentgoalsformonetarypolicy. inflationiszero,properlymeasured.However,
Further,Ibelievethatpricestabilitymustbethe biasesinpriceindexesimplythat,inpractice,
paramountobjectiveformonetarypolicybecause pricestabilitywilllikelybeconsistentwitha
withoutpricestability,thegoalsofmaximum smallpositivemeasuredrateofinflation.These
employment,moderateinterestratesandfinan- biasesarisefromthedifficultyofcapturing
1
MONETARYPOLICYANDINFLATION
improvementsinthequalityofgoodsandserv- barelyinsideoneendortheotherofa1to2per-
ices,aswellassubstitutionsamongproducts centrange.Asanaside,IwouldnotethatU.S.
thatcompriseconsumers’totalpurchases.Differ- monetarypolicyhascomealongwayoverthe
encesinhowpriceindexesareputtogetherimply past20years,asindicatedbythefactthatIthink
thatthespecificrateofinflationthatisconsis- itworthwhiletotalkaboutthedifferencebetween
tentwithpricestabilitywilllikelyvaryacross agoalof1.5plusorminus0.5percentversusa
countriesandovertime.FortheUnitedStates, goalof1to2percentinflation.
I’llhazardaguessthatzerotrueinflationtrans- Inamarketeconomy,consumersandfirms
latestoanannualrateofincreaseintheCPIof basetheirconsumptionandinvestmentdecisions
about1percentandinthebroaderpriceindex oninformationderivedfromprices,including
forpersonalconsumptionexpendituresofabout assetpricesandreturns.Efficientallocationof
0.5percent. economicresourcesdependsontheclarityof
Bypricestability,Idonotmeanthatthe signalscomingfromthepricesystemand,Imight
priceindexisconstant.Monetarypolicycould add,theclarityofsignalsfromgovernmentsand
nevereliminatehigh-frequencymovementsin
centralbanksabouteconomicpolicy.Uncertainty
theinflationrate;norshouldpolicymakerstryto
abouttheaggregatepricelevelmuddiesthewaters
doso.Pricestabilitymeansthatinflationissuf-
bymakingitdifficultforfirmsandhouseholds
ficientlylowandstableasnottoinfluencethe
todeterminewhetherchangesinindividual
economicdecisionsofhouseholdsandfirms.
pricesreflectfundamentalshiftsinsupplyand
Wheninflationislowandreasonablystable,
demandormerelychangesintheoverallrateof
peopledonotwasteresourcesattemptingtopro-
inflation.Byeliminatingthisuncertainty,amon-
tectthemselvesfrominflation.Theysaveand
etarypolicythatiscommittedtolong-runprice
investwithconfidencethatthevalueofmoney
stabilityeliminatesapotentialdragontheeffi-
willbestableovertime.
cientallocationofresourcesand,hence,oneco-
Ahighlypredictablefinancialenvironment
nomicgrowth.
notonlyrequiresalowandstablerateofinflation
Long-runpricestabilitycontributestofinan-
butalsowidespreadunderstandingofhowthat
cialstabilityinasimilarfashion.Anunstable
objectivestatedingeneraltermstranslatesinto
pricelevelcanleadtobadforecastsofrealreturns
day-by-daymonetarypolicyactions.Speaking
toinvestmentprojectsand,hence,tounprofitable
againintheU.S.context,itismoreimportant
borrowingandlendingdecisions.Unexpected
thatpolicymakersagreeonsomerelativelylow
boutsofinflation,forexample,tendtoencourage
targetrateofinflationthanexactlyonwhatthat
optimisticforecastsofrealreturns.Errorsindis-
rateis.AnumberofFOMCmembershavespoken
tinguishingnominalandrealreturnsresultin
abouta“comfortzone”of1to2percentinflation,
measuredbythePCEpriceindexexcludingfood misallocationofresourcesandeventuallyto
andenergy—theso-called“core”inflationrate. financialdistressthatwouldnothaveoccurred
Thatstatementisfullyacceptabletome.1My ifthepricelevelhadbeenstable.Businessdeci-
wayofstatingmycomfortzoneiscoreinflation sionsbasedonexpectationsofcontinuinginfla-
of1.5percentperyear,plusorminusarangeof tionoftenturnoutbadlywheninflationfalls,
0.5percenttoallowforunavoidableshort-run resultinginhigherratesofloandefaultsand
fluctuations.Mystatementismeanttoindicate businessfailures.Outrightdeflationisparticularly
thatIwouldlikemonetarypolicytoaimat1.5 notoriousbecauseafallingpricelevelincreases
percentcoreinflationandnotjustacceptinflation therealcostofservicingoutstandingdebt.
1 Andhasbeenforalongtime.Forarelativelyrecentexample,seeWilliamPoole,“TheMonetaryPolicyModel,”NationalAssociationof
BusinessEconomicsAnnualMeeting(NABE),Boston,Massachusetts, September11,2006[http://www.stlouisfed.org/news/speeches/
2006/PDF/09_11.pdf].
2
Inflation,FinancialStability,andEconomicGrowth
Long-runpricestabilityisthemostpowerful hamperedeffortstoencourageeconomicrecov-
toolthecentralbankhastopromoteeconomic ery.Hence,pricestabilitymadetheFed’sactions
growth,highemploymentandfinancialstability. moreeffectivethantheyotherwisewouldhave
Pricestabilityalsoenablesmonetaryauthorities been.
topursuesecondaryobjectives.Worthwhilesec-
ondarygoalsformonetarypolicyincludethe
reductionoffluctuationsinrealeconomicactivity LESSONS FROM U.S. ECONOMIC
andthemanagementoffinancialand/orliquidity
HISTORY
crises.Irefertotheseassecondarygoalsbecause
thecentralbankisunlikelytobesuccessfulat Whereasrecentexperiencesupportsthe
limitingfluctuationsineconomicactivityorcon- viewthatpricestabilitycontributestofinancial
tainingfinancialcrisesintheabsenceofprice stabilityandeconomicgrowth,thereisnoshort-
stability.Thereasonisthat,intheabsenceof ageofevidencethatanunstablepricelevelleads
entrenchedmarketexpectationsoflong-runprice tofinancialinstabilityandapoorlyperforming
stability,basedonahighdegreeofconfidencein realeconomy.Sadly,historyisfullofexamples
thecentralbank,expansionarymonetarypolicy wheremismanagedmonetarypolicyresultedin
actionsriskraisinginflationexpectationsrather financialinstabilityandseriousdisruptionof
thancushioninganeconomicorfinancialdistur- economicactivity.TheexperiencesoftheUnited
bance.Pricestabilitymustthereforebetheprin- StatesduringtheGreatDepressionofthe1930s
cipalgoalofpolicy.Acentralbankthatinvests andtheGreatInflationofthe1970sprovidetwo
inachievingcredibilitywillfindthatmarket suchexamples.
confidenceyieldsaveryhighrateofreturn. TheGreatDepressionisaclassicillustration
TheFederalReservehasfacedanumberof ofhowfinancialdisruptionscanwreakhavocon
challengesinrecenthistory,includingliquidity therealeconomy.PolicymistakesbytheFederal
shocksassociatedwiththeAsianfinancialcrisis Reservewerecritical,asMiltonFriedmanand
andRussiangovernmentbonddefaultin1998, AnnaSchwartzdemonstratedintheirMonetary
andtheterroristattacksofSeptember11,2001. HistoryoftheUnitedStates.TheFed’sprincipal
TheFed’sabilitytorespondquicklyanddeci- errorwasinfailingtoactaslenderoflastresort
sivelytotheextraordinarydemandsforliquidity tothebankingsystemasbankingpanicsswept
duringtheseeventswasenhancedbythefact acrosstheUnitedStates.Thecollapseofthebank-
thatinflationwaslowandexpectedbythepub- ingsystemcausedthemoneystocktocontract
lictoremainlow.Thepublicunderstoodthatin sharply,whichcausedthepriceleveltofall.
providingadditionalliquidityduringthecrises Deflationdroveuptherealcostofservicingdebt
theFederalReservewasnotgivinguponitspur- andledtowidespreadbusinessfailuresand
suitofpricestabilityoverthelongterm. unemployment.Fallingincomesandincreased
Lowinflationandcontainedinflationexpec- loandefaultsputfurtherstrainonbanksand
tationshavealsoenhancedtheFederalReserve’s otherfinancialfirms.FailureoftheFederal
abilitytoreacteffectivelytobusinesscyclefluc- Reservetoactintimelyfashioncreatedadown-
tuations.TheFedeasedaggressivelytoencour- warddebt-deflationspiral.Morethan1,000banks
ageeconomicrecoveryfromthe2001recession. wereforcedtosuspendoperationsineachyear
BecausethepublichadconfidenceintheFed’s between1930and1933.
commitmenttopricestability,wewereableto Themonetaryhemorrhagefinallyended
bringthetargetfederalfundsratetoitslowest whentheentirebankingsystem,includingthe
levelin40yearswithouttriggeringwidespread FederalReservebanks,wasshutdownbygovern-
fearsofhigherinflation.Ifexpectedinflation mentdecreeinMarch1933.Onceconfidencein
hadrisenastheFedbroughtratesdown,long- thebankingsystemhadbeenrestored,themoney
terminterestrateswouldlikelyhaverisenand stockandpricelevelbegantorise.Thereal
3
MONETARYPOLICYANDINFLATION
interestratefellasthepricelevelrose,which Thereweresomenotabledissentsfromthis
encouragedincreasedbusinessinvestmentand view.MiltonFriedmanandEdmundPhelps
consumerspending,andtheeconomybeganto arguedstronglythatinflationarypoliciescould
recover. notboostemploymentoreconomicgrowthin
TheGreatDepressionillustrateshowdefla- thelongrun,andthatattemptstodosowould
tioncanwreckafinancialsystemandeconomy. produceeverhigherinflationbutnomore
TheGreatInflation,bycontrast,showedthe employmentorgrowththanwaspossiblewitha
destructivepowerofinflation.Inflationbeganto stablepricelevel.
riseinthemid1960s.Itisinterestingtocompare TheviewsofFriedmanandPhelpsbecame
attitudestowardrestrictivemonetarypolicyin increasinglyacceptedinthe1970saseconomists
thelate1960sandattitudesnow.Fortyyearsago, cametoappreciatetheimportanceofexpecta-
therewasgreatconcernintheUnitedStatesthat tionsintheeconomicdecisionmakingoffirms
higherinterestrateswouldhaveanundueimpact andhouseholds.Atatheoreticallevel,economists
onhousingfinanceandhousingconstruction; showedformallythatwhenthepubliccomesto
thatconcerncontributedtodelaysinneeded expectthatpolicymakerswillattempttouseinfla-
FederalReservepolicyactionsthatendedup tiontoboostemploymentoreconomicgrowth,
destabilizingtheentireeconomy.Now,weunder- thepublicwillrespondinwaysthatprevent
standthatmonetarypolicymustconcentrateon employmentoroutputfromrising.Forexample,
thegoalofaggregateeconomicstabilityand ifinflationisexpectedtorise,thenworkerswill
especiallyinflationcontrol.Weregardstresses demandhighernominalwagesandsaverswill
inanyparticularindustryasaproblemforthat demandhighernominalinterestratestoprevent
industrytodealwith;thosestressesarenotan realwagesandinterestratesfromfalling.Conse-
issueformonetarypolicy,unlesstheyspillover quently,oncethepublicfiguresoutthecentral
totheeconomymoregenerally. bank’sgame,inflationarymonetarypolicywill
Inthe1960s,politicalpressureforlowinter- havenoeffectonemploymentoroutput.
estratescombinedforceswithagrowingcon- Atanempiricallevel,asthe1970sprogressed
sensusamongeconomistsandpolicymakersthat theperformanceoftheeconomydiscreditedthe
moderateinflationisanacceptablewaytoboost notionthathigherinflationcouldproducehigher
employmentandeconomicgrowth.Monetary employmentandfastergrowth.Ifanything,the
policymakingwasviewedassimplyamatterof dataindicatedjusttheopposite.Asinflation
selectingfromamongamenuofinflationand rosestillhigherandbecamemorevariable,the
unemploymentoptions.Choosealittlemoreinfla- averagegrowthrateoftheU.S.economyslowed
tionandunemploymentwouldfall,accordingto andbusinesscyclefluctuationsbecamemore
thistheory.Acceptsomewhathigherunemploy- pronounced.
ment,ontheotherhand,andinflationwouldbe Inflation,andespeciallyinflationinstability,
abitlower. proveddisruptiveforfinancialmarketsandfirms.
TheinfamousPhillipscurvemadepolicy- Initiallytheimpactoftheintensifyinginflation
makingseembeguilinglysimple.Basedonthis seemedbenignwithrespecttofinancialmarkets
theory,severalinfluentialeconomistsargued andfinancialstability.Belowthesurface,how-
thatthemenuofinflation-unemploymentoptions ever,therisinginflationwasinteractingwiththe
offeredbythePhillipscurvecouldbeimproved financialregulatorystructurethathadbeen
uponifpolicymakerswerewillingtodiscard establishedinthe1930sinresponsetothefail-
theirold-fashionedattractiontopricestability. uresoftheGreatDepression.
Foregopricestability,theseeconomistsargued, Mutualsavingsbanksandsavingsandloan
andthelabormarketwouldoperatemoreeffi- associations—the“thriftinstitutions”—had
ciently,employmentwouldriseandtheeconomy becomethemainstayofhousingfinanceinthe
wouldgrowfaster. UnitedStatesafterWorldWarII.Thesefinancial
4
Inflation,FinancialStability,andEconomicGrowth
intermediariesborrowedshortandlentlong—a economyasawhole,butdidseverelyaffect
classicdurationmismatch.Asinflationpremiums farmingregions.
becamebuiltintomarketinterestrates,short-term TheU.S.inflationenvironmentwasfairly
interestratesrosemuchmorerapidlythandid stableinearly1965,andfairlystableagainin
thereturnonthethrifts’assets,whichwere 1985.The20yearsinbetweensawthefailureof
heavilyinvestedinfixed-rate30-yearhome scoresofbanksandthriftinstitutionsandof
mortgages.By1980,onamarked-to-marketbasis thousandsoffarmsandtwodeeprecessions,in
thecapitalofalargeportionofthethriftindustry 1973-75and1981-82.Hundredsmorethriftinsti-
wasexhausted. tutionswereclosedinthelate1980sandearly
Althoughtheindustrywaskeptafloatfora 1990swhentheU.S.governmentfinallyfacedup
timebygovernmentsanctionedaccounting tothefactthattheyhadexhaustedtheircapital
gimmicks,manythriftswerewalkingdead— duringtheGreatInflation.
“zombies”somecalledthem—thathadtobe Thegeneralprinciplecommontothesecases
closed.Becausethedepositliabilitiesofmost offinancialdistressisthatsignificantchangesin
thriftswerefederallyinsured,thecollapseofthe theinflationratecannotbeaccuratelyforeseen.
industrywascostlyfortaxpayers.Thecleanupis Forecastingerrors,andresultingfinancialloses
estimatedtohavecostU.S.taxpayersbetween andbankruptcies,areinevitablewhentheprice
150and200billiondollars.Itisworthnoting levelisunstable.Inshort,inflationandinflation
thatdepositinsurancedidfunctioneffectively instabilityputaneconomy’sfinancialsectorat
inmaintainingthepublic’sconfidenceinthe risk.
bankingsystem.Nevertheless,intheabsenceof
highinflation,theepisodecouldlargelyhave
beenavoided. LESSONS FROM HIGH
Inflationdeclinedsharplyintheearly1980s,
INFLATION EXPERIENCES
thankstoachangeinthecourseofmonetary
policyundertheleadershipofPaulVolcker,then AlthoughIhavefocusedonU.S.experiences,
ChairmanoftheFederalReserveBoard.The whichIknowbest,manyothercountrieshave
declinewaslargelyunanticipated.Becausefew seenthedeleteriouseffectsofpricelevelinstabil-
peopleexpectedinflationtoremaincontained, ity.Indeed,somehavehadfarworseexperiences
realinterestratessoaredassaverscontinuedto thantheUnitedStates.Manylesserdeveloped
demandhighinflationriskpremiums.Thedollar countrieshaveexperiencedveryhighratesof
alsoappreciatedsharplyinworldforeignexchange inflationatonetimeoranother,oftenwithdisas-
markets.ThestrongdollarwashardonU.S. trousconsequencesforfinancialstabilityand
exportersandparticularlydevastatingforfarmers economicgrowth.
asthedollarpricesofagriculturalcommodities Inastudyofcross-countrydata,RobertBarro
fellsharply.Manyfarmershadborrowedheavily foundthathighratesofinflationsignificantly
topurchaselandduringthe1970swhencommod- reduceeconomicgrowth,evenafteronecontrols
itypricesweresoaringandlandvalueswere forsuchinfluencesongrowthaseducational
appreciatingrapidly.Fallingcommodityand attainmentlevels,theruleoflawandstrengthof
landpricesinthe1980sleftmanyfarmersunable democraticinstitutions.2MichaelBrunoand
toservicetheirdebtsandmanywentbankrupt. WilliamEasterlyoftheWorldBankreportsimilar
Lossesonfarmloanscausedthefailureofmany evidence.Theyfindthatinflationcrises—which
banksinagriculturalregionsoftheUnitedStates. theydefineasinflationratesontheorderof40
Thisfinancialdistressdidnotspreadtothe percentormore—producesignificantshortfalls
2 RobertBarro,“InflationandGrowth.”FederalReserveBankofSt.LouisReview,May/June1996,78(3),pp.153-69.
5
MONETARYPOLICYANDINFLATION
inacountry’seconomicgrowth.3Forexample, performanceoverthepast15years,whichthe
whenChile’sinflationratesoaredfromanaver- IMFattributedlargelytotheimplementationof
agerateof27percentbetween1960and1971to soundeconomicpolicies.Duringthe15years
anaveragerateof240percentbetween1972and endingin2005,ChileenjoyedanaverageGDP
1977,thecountry’salreadymodestrateofper growthrateof5.5percent,atriplingofitsper
capitaoutputgrowthdeclinedfromjustunder capitaincomeinU.S.dollarterms,andahalving
theworldaveragetomorethan5percentage ofitspovertyrate,allwhilekeepingthelidon
pointsbelowtheworldaverage.Brunoand inflation.TheIMFcitedChile’ssoundfiscalpoli-
Easterlyshowthatothercountriesthathavehad cies,itslowbarrierstointernationaltradeand
capitalflows,soundfinancialregulatoryand
suchinflationaryburstsalsoexperiencedlarge
supervisoryframework,afloatingexchangerate,
declinesinoutputgrowth.
anditsinflation-targetingframeworkformone-
Perhapsthemostobviousexamplesofthe
tarypolicy.Thesepolicies,theIMFargues,have
destructiveforceofinflationarehyperinflations
helpedkeepinflationandinflationexpectations
inGermanyafterWorldWarI,invariouseastern
low,sustainedeconomicgrowthandhelped
EuropeancountriesafterWorldWarIIandin
maketheChileaneconomyresilienttoexternal
LatinAmericamorerecently.Thesewerecaused
shocks.4
byprintingmoneytofinancemassivegovernment
LikeChile,manycountrieshavemadeprice
budgetdeficits.Hyperinflationwasendedin
stabilitytheparamountobjectiveofmonetary
thosecountriesbyreformsthatbroughtgovern-
policy,andseveralhaveadoptedformalinflation
mentspendingundercontrolandcrediblyended
targetingasawayofanchoringinflationexpec-
thefinancingofdeficitsbyprintingmoney.
tations.Theadvantageofadoptingaformal
Economistshavedebatedwhetherthetermina-
quantitativetargetforinflation,especiallywhen
tionofhyperinflationsresultedinseriousdeclines
coupledwithinstitutionalreforms,suchas
inoutput.Itiscertain,however,thathyperinfla-
increasedoperatingindependenceforcentral
tiondidnotpromotefastergrowthorfinancial
banks,isthatitreducesuncertaintyaboutthe
stability.Hyperinflationswenthandinhandwith
long-terminflationrate.This,inturn,reduces
collapsingeconomiesandfinancialmarkets.
inflationriskpremiumsininterestratesandpro-
Countriesthathaveveryhighratesofinfla-
moteslong-termcontractingandinvestment.
tiontypicallyhaveweakinstitutions,including
Thesebenefitscanbeespeciallyimportantfor
poorenforcementofcontractsandpropertyrights,
countriesthathavehadahistoryofhighor
andinefficienttaxsystems(andconsequently
unstableinflation.However,Ibelievethatany
largebudgetdeficits).Manycountrieshavemade
countrycouldbenefitfromannouncingand
effortstoimprovetheirpoliticalandeconomic
stickingtoaspecificnumericinflationobjective.
institutionsandarenowexperiencinglower
inflationandhighereconomicgrowththanthey
didbeforetheirreforms.
CONCLUSION
Chileisoneexampleofacountrythatappears
tohaveseenadirectbenefitfromimplementing Iwillconcludebynotingthat,overthepast
pro-economicgrowthpoliciesthatincludemeas- 20yearsorso,theinflationrecordoftheUnited
urestocontrolinflation.Theexecutiveboardof Statesandmanyothercountrieshasbeenfar
theInternationalMonetaryFund(IMF)recently betterthanitwasfromthemid1960stotheearly
complimentedChileforitsenviableeconomic 1980s.Itisnotacoincidence,Ibelieve,thatwe
3 MichaelBrunoandWilliamEasterly,“InflationandGrowth:InSearchofaStableRelationship.”FederalReserveBankofSt.LouisReview,
May/June1996,78(3),pp.139-46.
4 “IMFExecutiveBoardConcludes2006ArticleIVConsultationwithChile.”PublicInformationNoticeno.06/97.August11,2006.
6
Inflation,FinancialStability,andEconomicGrowth
havealsohadabetterrecordofeconomicgrowth associatedwithalittleinflation,andbadtimes
andfinancialstabilityovertherecenttwodecades withfallinginflationor,especially,deflation.That
thanduringtheyearsofhighandhighlyvariable observationiscorrectbutincomplete.Alittle
inflation.FederalReserveChairmanBenBernanke unexpectedinflationisassociatedwithtemporary
hasreferredtothedeclineinthevolatilityof goodtimesbutcannotlast.Expectationscatch
bothinflationandoutputoverthepast20years upwithreality.Asexpectationsandactualinfla-
as“TheGreatModeration.” tionrise,thegoodtimescometoanendand
Duringtherecentpast,ourfinancialsystem financialinstabilitybegins.AsMiltonFriedman
andeconomyhaveshownremarkableresilience arguedsobrilliantly,foraneconomyoperating
inthefaceofsomeseriousshocks.Ihavealready closetofullemployment,thetrade-offisnot
mentionedtheAsianfinancialcrisisandRussian betweeninflationandunemploymentbutbetween
governmentbonddefaultin1998,andtheterrorist unemploymentnowandunemploymentplus
attacksofSeptember11,2001.Noneofthesehad inflationlater.
morethanapassingimpactonU.S.financial UndertheFederalReserveAct,theFedoper-
marketsorfirmsorontherealeconomy.More ateswithadualmandate,toencouragemaximum
recently,wehaveseenlittlefalloutfromtheend- employmentandpricestability.Thosegoalsare
ingofthehousingboom.Atleastthusfar,only notincompatiblebutfundamentallythesame
theresidentialconstructionindustryandclosely goal.Maintaininglowandstableinflationiscen-
alliedindustriesandprofessionshaveexperi- traltoachievingmaximumemploymentandthe
encedanysignificanteffectsoftheslowingof highestpossiblerateofeconomicgrowth.Main-
housingmarkets.Needlesstosay,Idoubtthatour tainingpricestabilitydoesnotrequirethatthe
financialsystemoreconomywouldshowsuch centralbankcomedownhardoneveryupward
resilienceifinflationwerenotlowandstable. twitchintheinflationrate,butdisciplined
Monetarypolicyisnotmagic.Astablecur- responseisrequiredwhentheinflationrate
rencyisanecessarybutnotsufficientcondition threatenstoriseinasustainedfashionorfall
foreconomicgrowth.Ademocraticgovernment, intodeflation.Centralbankersneedtoapply
abletotransferpowerpeacefullyandreliably,is theirbestjudgment,andtheywillnotalwaysbe
essentialtosustainedprosperity.Soalsoare correctinthosejudgments.Butiftheyhavea
soundlegaltraditionsandprocessestoresolve goodrecordandthemarketretainsconfidence
disputesaccordingtothelaw.Governmentsneed thatthecentralbankwillcorrectitsmistakes,
topursuepoliciesthatencourageentrepreneur- errorsinjudgmentwillnotdolastingdamage.I
ialactivity.Asocialsafetynetisimportantin myselfrelyheavilyonmarketmeasuresofinfla-
today’sworld,butitmustnotdestroyincentives tionexpectationsinformingmyjudgmentsand
forfirmstohireproductiveworkers.Inamarket indecidingwhatpolicyriskstorun—inanuncer-
economy,thosewhotakerisksshouldberewarded tainworld,itisalwaysthecasethatpolicyjudg-
whentheyaresuccessfulandshouldsufferlosses mentsdependonprobabilisticcalculations.
whentheyarenot.Monetarypolicycannotoffset IhopethatIhavepersuadedyouthatfinan-
governmentpoliciesdestructiveofthegrowth cialstabilityandeconomicgrowthareenhanced
process. bypricestability.ButIknowthatactualexperi-
Ifinishbynotingacommonmisunderstand- enceintheUnitedStates,inChileandinmany
ing.Inmanycountries,includingtheUnited othercountriesismorepersuasivethatwords
States,thereistheviewthatgoodtimesareoften caneverbe.
7
Cite this document
APA
William Poole (2007, March 4). Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/speech_20070305_poole
BibTeX
@misc{wtfs_speech_20070305_poole,
author = {William Poole},
title = {Speech},
year = {2007},
month = {Mar},
howpublished = {Speeches, Federal Reserve},
url = {https://whenthefedspeaks.com/doc/speech_20070305_poole},
note = {Retrieved via When the Fed Speaks corpus}
}