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Translating Yellin: The FED's Mistress of Fog
Nov. 15, 2012
Janet Yellin is Vice Chairman of the Federal Reserve's Board of Governors.She has been assigned the task of making the FED more transparent. She is the chairman of a new Federal Open Market Committee (FOMC) communications subcommittee.
Let me say from the beginning that Janet Yellin makes Ben Bernanke sound like Henny Youngman.
Anyone who reads a Janet Yellin speech while smoking in bed is not a good insurance risk.
Her recent speech reveals new thinking at the FED. (I use the term "reveals" advisedly.) She gave this speech at the University of California, Berkeley, where she used to teach. (I use the term "teach" advisedly.)
As you may know, I am an unofficial translator of Federal Reserve speeches. I will help guide you through Dr. Yellin's speech.
The FED relies on her to get its message across.
My subject is the recent revolution and continuing evolution in communication by central banks. All of us, of course, live in an era of revolutionary advances in communication: If I succeed in saying anything interesting this afternoon, those words may be posted, tweeted, and blogged about even before I've left this podium. So, it might seem unsurprising that the Federal Reserve, too, is bolstering its efforts at communication.
Translation: "The FED is communicating, all right. It just isn't communicating anything of substance. If you doubt me, read the rest of my speech. See if you find anything interesting."
But the revolution in central bank communication is not driven by technological advances. Rather, it is the product of advances in our understanding of how to make monetary policy most effective.
Translation: "Our previous understanding of how to make monetary policy effective was unfortunately weak. For example, Bernanke's textbook doesn't let anyone predict anything anymore."
A growing body of research and experience demonstrates that clear communication is itself a vital tool for increasing the efficacy and reliability of monetary policy.
Translation: "Too bad nobody at the FED knows how to use this vital tool. Doubt me? Keep reading."
In fact, the challenges facing our economy in the wake of the financial crisis have made clear communication more important than ever before.
Translation: "That's why the FED's lack of 'transparency' stands out like a sore thumb. I am here today to call this opaqueness 'transparency.'"
Today I'll discuss the revolution in thinking about central bank transparency and how, pushed by the unique situation precipitated by the financial crisis, the Federal Reserve has responded with fundamental advances in communication. Indeed, I hope that one of the legacies of this difficult period is a permanent and substantial advance in Federal Reserve transparency, building on the policies I'll talk about shortly.
Translation: "Above all, we do not want an independent audit of the FED. I am here to try to deflect your attention from this obvious fact. When I say "transparency,' think 'No audit of the FED by the Government Accountability Office.'"
As you all know, the Federal Reserve is actively promoting a faster recovery. Our efforts are hampered by the fact that our standard policy tool, the federal funds rate, is near zero and cannot be reduced much further.
Translation: "As I said before, nothing is working the way Keynesian textbooks said it should."
In this extraordinary environment, the Federal Reserve is employing two unconventional policy tools to spur job creation and growth: large-scale asset purchases, which some people call quantitative easing, and communications about the future course of monetary policy, also known as forward guidance.
Translation: "We are inflating as never before in peacetime, and we are also trying to plan the entire economy. When I say 'forward guidance,' think 'plan the economy.'"
At the Federal Open Market Committee's (FOMC) meeting in September, the FOMC--the Federal Reserve's principal monetary policymaking body--employed both of these unconventional tools. The Committee initiated a new large-scale asset purchase program to buy mortgage-backed securities (MBS). In addition, with regard to forward guidance, the Committee said that, first, it intends to continue buying MBS and other assets until it sees a substantial improvement in the outlook for the labor market. Second, the Committee stated that it expects a highly accommodative stance of monetary policy to remain appropriate for a considerable time after the economic recovery strengthens. And third, the Committee noted that it currently expects to hold the federal funds rate at exceptionally low levels at least through mid-2015, about a half-year longer than previously announced.
Translation: "So far, there has been no quantitative easing. Yes, the FOMC announced its new policy on September 13. Since then, the adjusted monetary base is lower. At the FED, we honor the legacy of Attorney General John Mitchell, before he went to prison. 'Watch what we do, not what we say.' Here is what we have done. Of course, you rubes are not smart enough to look it up, so nobody is the wiser, except at the St. Louis FED, which is run by a bunch of wacko Friedmanites."
The three elements of forward guidance that were adopted by the FOMC in September 2012 would have been unthinkable in 1992 and greatly surprising in 2002, but they have, in my view, become a centerpiece of appropriate monetary policy.
Translation: "Anyway, that's the official Party Line. In fact, we are doing the opposite."
To better explain my views regarding the FOMC's forward guidance, I will first discuss how it fits into the Committee's broader thinking and communication about monetary policy.
Translation: "Here comes the song and dance."
The FOMC took a major step to explain this thinking last January when it issued for the first time a "Statement of Longer-Run Goals and Policy Strategy." This statement provides a concise description of the FOMC's objectives in conducting monetary policy and the approach the Committee considers appropriate to achieve them.
Translation: "And, one of these days, the FOMC may actually implement it. You never know."
I will present my views on the implications of this statement for monetary policy in current circumstances. I will then discuss several approaches the FOMC has recently considered to enhance its communications to make its policy more effective in this challenging situation. Let me emphasize that the views I express here are my own and do not necessarily represent those of my colleagues in the Federal Reserve System.
Translation: "Sit back and relax. I will now tell you a story. It's just my story. It's not necessarily anyone else's story."
The Case for Central Bank Transparency
To fully appreciate the recent revolution in central bank communication and its implications for current policy, it is useful to recall that for decades, the conventional wisdom was that secrecy about the central bank's goals and actions actually makes monetary policy more effective.
Translation: "Back then, we could keep out snoopers. Those were the good old days of central banking. Central bankers could mess with the economy, and no one was the wiser. No one said anything, except Ron Paul, and he lost his bid for re-election in 1976."
In 1977, when I started my first job at the Federal Reserve Board as a staff economist in the Division of International Finance, it was an article of faith in central banking that secrecy about monetary policy decisions was the best policy: Central banks, as a rule, did not discuss these decisions, let alone their future policy intentions. While the Federal Reserve is required by the Congress to promote stable prices and maximum employment, Federal Reserve officials at that time avoided discussing how policy would be used to pursue both sides of this mandate. Indeed, mere mention of the employment side of the mandate, even by the mid-1990s, was described in a New York Times article as the equivalent of "sticking needles in the eyes of central bankers."
Translation: "We could get away with murder back then, and we did. The FED was run by G. William Miller, who inflated the dollar into the worst post-war inflationary crisis in modern history."
This secretiveness regarding monetary policy decisions clashed with the openness regarding government decisions expected in a democracy, especially since Federal Reserve decisions influence the lives of every American.
Translation: "Not only did we run the economy secretly, no college-level textbook said this was bad. They all cheered us on. They stood firm against all that democracy blather. By the way, no textbook brings this up these days, either. So, we are still running the show. Suck it up, rubes."
And there were critics within the economics profession. James Tobin and Milton Friedman, both Nobel laureates, disagreed on almost every aspect of monetary policy, but they were united in arguing that transparency regarding central bank decisions is vital in a democracy to lend legitimacy to policy decisions.
Translation: "That was a cloud no larger than a man's hand, to quote the Bible."
Surely only some important societal interest requiring opacity could justify the traditional practice. Indeed, in 1975 a citizen demanding greater openness sued the FOMC to obtain immediate release of the policy directive upon its adoption, and in 1981 the case was resolved in favor of deferred disclosure.
Translation: "Before Miller screwed the pooch, we had it made."
Ironically, while this transparency lawsuit was wending its way through the courts, Robert Lucas and others were publishing research that would garner several Nobel prizes and ultimately overturn the traditional wisdom that secrecy regarding policy actions was the best policy.
A key insight of these scholars was that monetary policy affects employment, incomes, and inflation to a large extent through its effects on the public's expectations about future policy. Many spending decisions, such as financing the purchase of a home or businesses' capital expenditures, depend on longer-term interest rates that are connected to monetary policy through expectations of short-term interest rates over the lifetime of a mortgage or an investment project.
Translation: "Public expectations about interest rates count. That was what Austrian School economists had been saying ever since 1912. But they did not have any formulas or higher math, so no respectable economist paid any attention. Those were the good old days."
The history of oil price shocks is a good example to illustrate this point. In the 1970s, two large oil price shocks led to sharp increases in general inflation that were not met with prompt inflation-fighting actions by the Federal Reserve. This delay left the public unsure whether the Federal Reserve would act to reverse the increase in inflation, and expectations of longer-term inflation ratcheted up.
When the Federal Reserve eventually did act to bring inflation down from double-digit levels, the consequence was the painful recession of 1981 and 1982.
Thus, over the quarter century up to the mid-2000s, the Federal Reserve established a record of policymaking that allowed the public to predict monetary policy responses to unforeseen events such as an oil price shock with reasonable accuracy.
Translation: "I like to talk about oil. I prefer not to talk about Greenspan's housing bubble. You can understand why."
Unfortunately, recent events have made it harder for the public to predict the future course of monetary policy. Economic weakness since the financial crisis and the Great Recession has confounded hopes for a speedy recovery and has required unprecedented monetary policy actions. Shortly after the financial crisis erupted, the Federal Reserve reduced the federal funds rate to almost zero and launched a number of temporary liquidity and credit programs to keep the financial system operating. Even these aggressive policy responses, however, were not enough to halt the contraction, and further action was needed to stop the economy from falling into a second Great Depression.
Translation: "The Austrian economists saw this coming, and said so. Boy, are they lucky guessers! A stopped clock is right twice a day."
To this end, the Federal Reserve started to expand its balance sheet through purchases of longer-term Treasury securities and agency debt and MBS in an effort to put further downward pressure on long-term interest rates and so stimulate the economy.
Translation: "Rates went down. The economy barely went up. As I said, nothing is working as planned anymore."
With the federal funds rate near zero, and the Federal Reserve deploying the new tool of large-scale asset purchases, it became much more difficult for the public to anticipate how the FOMC would likely conduct policy over time, and how the overall stance of monetary policy would both affect and respond to economic conditions.
Translation: "It was difficult for the public to anticipate the FOMC mainly because nobody at the FOMC could figure out what the FOMC would do next."
In this situation, the FOMC began to rely heavily on forward guidance about both the likely future path of the federal funds rate and the Committee's intentions concerning asset purchases and sales.
Translation: "'Forward guidance' means central planning through monetary manipulation."
But, for this guidance to have its maximum effect, it must be understood and believed by the public, and therefore provide the public with a solid basis for forming their borrowing and spending decisions today. In my view, such credibility can be achieved only if the public understands the FOMC's objectives and intentions.
Translation: "If people would just believe us, maybe the policies would work. So far, nothing is working as planned."
Communications after the Financial Crisis
Chairman Bernanke asked me to take up these challenges in 2010 as chair of a new FOMC communications subcommittee. Central bank transparency had long been an issue of great interest to both of us, and the Chairman had been an exceptionally strong voice for central bank transparency in his academic work and in his earlier service on the Board of Governors.
Translation: "It's my job to try to get people to believe us. If you think this is a picnic, think again."
Throughout the Chairman's term, the FOMC has made important strides in transparency through actions such as introducing the Committee's quarterly Summary of Economic Projections (SEP), which provides information about participants' forecasts for the economy under their individual views concerning appropriate policy and their longer-run assessments of potential output growth, the "normal" unemployment rate, and the most appropriate inflation rate.
Translation: "This sounds good, but since nothing is working as planned, all of this data on forecasts keeps coming out the same: grim. Nobody expects this economy to work. The banks are not lending. So, the FED has no leverage. We get very little bang for our counterfeit bucks."
A high priority for the Chairman was to further clarify the FOMC's interpretation of the long-term objectives implied by its dual mandate to promote maximum employment and stable prices. While we had made progress, as I just noted, during the years preceding the crisis, the FOMC as a body had never provided an explicit description of its policy goals beyond quoting its mandate.
Translation: "When you don't have to tell anyone anything for 80 years, it's hard to make the transition to fake transparency, and make it believable."
We saw further clarification of these objectives as important for the sake of transparency and accountability. But beyond that, an explicit statement of goals had become essential for the Committee to achieve its monetary policy objectives in the aftermath of the crisis, including allowing heavier reliance than in the past on forward guidance on the future path of policy.
Translation: "If we can keep people focused on our policy goals, maybe they will not notice that we have no coherent explanation of how any policy that we might conceivably adopt will enable us to reach our policy goals."
A particular concern, given that the crisis had ushered in a prolonged period of elevated unemployment, was that the weakness in the economy might push inflation well below 2 percent, a level that many took to be an implicit target of the FOMC. There was even an ongoing risk that low inflation might turn to deflation and further hamper growth. These challenges led to legitimate questions among forecasters and the public about just what the FOMC meant by "maximum employment" and "stable prices."
Translation: "People keep asking legitimate questions. That is our problem. We have no coherent answers, which is why I have to give speeches like this one: long on rhetoric, short on answers."
The FOMC could have chosen to adopt an "inflation-targeting framework," in which it would have specified an objective solely for inflation, without any explicit reference to employment.
Translation: "It would have done that, except price inflation is low because banks will not lend, and the economy is in the dumpster. Unemployment is the problem, and nothing the FOMC has done has helped lower it much."
Such an approach has been adopted by a large number of central banks since the 1990s. While the FOMC had debated adopting an inflation target on a number of occasions since the mid-1990s, some Committee members believed that stating an explicit target for inflation alone would undermine the maximum-employment side of the dual mandate. In fact, some central banks that have been assigned a single mandate of inflation stabilization have struggled to explain how the goals of growth and financial stability figure into their inflation-targeting framework.
Translation: "Nothing is working for any central bank. The whole framework is breaking apart, all over the world."
A Consensus on Monetary Policy Goals
Last January, the FOMC took a major step to clarify its interpretation of its dual mandate, issuing the "Statement of Longer-Run Goals and Monetary Policy Strategy" that I mentioned earlier. Unlike the regular postmeeting statements, which are intended to remain current only until the next FOMC meeting, this statement is meant to be a more enduring expression of the FOMC's policy objectives and how it plans to pursue them. The intention is that the public can count on the principles expressed in the statement to remain unchanged for some time to come, even as the economic outlook changes.
Translation: "Price inflation was low, so we all agreed to focus on unemployment. From now on, we are going to talk about unemployment . . . until price inflation resurfaces because banks start lending."
Importantly, the consensus statement provides a numerical value--2 percent--for the Committee's longer-run inflation goal. But importantly, it pairs that inflation goal with a specific goal for maximum employment. In particular, the statement cites a range summarizing FOMC participants' estimates of the longer-run normal rate of unemployment. Finally, the statement says that the Committee will follow a "balanced approach" as it "seeks to mitigate deviations of inflation from its longer-run goal and deviations of employment from the Committee's assessments of its maximum level."
Translation: "We will expand the monetary base one of these days. And when we do, we will see if price inflation rises. We will see if unemployment falls. If nothing changes, we will then simply announce the same goals until something happens."
Given that the rate of inflation over the longer run is determined solely by monetary policy, central banks can, and indeed must, determine the long-run level of inflation.
Translation: "We are still in charge. So, when the rate of price inflation rises to meet the unemployment rate, which refuses to come down, I will probably retire."
In contrast, they cannot do much to affect the maximum sustainable level of employment. That level is determined by factors affecting the structure and dynamics of the labor market that are almost completely outside the control of the central bank.
Translation: "Don't blame us for high unemployment. That's not our fault. That double mandate stuff is a load of fecal material. We are taking responsibility only for price inflation, since it is low. When it goes above 10%, I will probably retire."
Setting Longer-Run Objectives and Minimizing Shorter-Run Fluctuations
As I mentioned before, stating longer-run goals is only one part of clarifying the dual mandate. The other part involves explaining how the FOMC will conduct policy to attain its longer-run objectives over time.
Translation: "Explanation of cause and effect. You yokels have been waiting for this ever since 2008. Well, you're going to wait a lot longer."
We can therefore think of two tasks for monetary policymakers: first, setting policy to pursue the longer-run objectives; and second, adjusting policy in response to shocks to minimize shorter-run fluctuations around those objectives.
Translation: "Think of these two objectives as 'Somewhere, over the rainbow, way up high,' and 'print money and lend it to New York banks at a below-market rate.'"
Clarity on longer-run goals, due to the important role of expectations, can itself help reduce short-run fluctuations.
Translation: "If we can keep you focused on our long-run policy goals, you may not notice the next meltdown. Anyway, I hope not."
In the words of the January consensus statement, "communicating this inflation goal clearly to the public helps keep longer-term inflation expectations firmly anchored, thereby fostering price stability and moderate long-term interest rates and enhancing the Committee's ability to promote maximum employment in the face of significant economic disturbances."
Translation: "Think of a pea under half a walnut shell. Keep your eye on the pea. Ignore the other two walnut shells."
Put differently, the purpose of providing greater clarity about the FOMC's longer-run inflation goal is to anchor inflation expectations more firmly. These more firmly anchored expectations in turn free the Committee's hand to more actively and effectively stabilize short-run fluctuations in economic activity.
Translation: "Put differently, this is a shell game."
The Committee can act in this way because the FOMC can tolerate transitory deviations of inflation from its objective in order to more forcefully stabilize employment without needing to worry that the public will mistake these actions as the pursuit of a higher or lower long-run inflation objective.
Translation: "Notice the shift. Before, I said we are not responsible for high unemployment, which is beyond our control. But we can stabilize employment. If you do not understand this, that's because you're either a yokel or an Austrian School economist."
The instability of inflation, inflation expectations, and employment in response to the oil price increases of the 1970s vividly illustrates the threat posed by price shocks when longer-term inflation expectations are not well anchored.
Translation: "Keep thinking about oil. Ignore the housing market."
The goals of stable prices and maximum employment are often complementary: Policymakers need not sacrifice performance on one goal to pursue the other.
Translation: "Things worked prior to 2008."
However, the pursuit of the two sides of the dual mandate can temporarily conflict. For example, returning inflation to its longer-run goal might require, say, a tighter stance of monetary policy, whereas returning the economy to maximum employment might require just the opposite.
Translation: "So, we're damned if we don't inflate, and damned if we do. So, we will continue to bloviate."
The consensus statement explains that in such circumstances the FOMC will pursue a balanced approach, taking into account the magnitude of the deviation of each variable from its objective and allowing for the possibility that the deviations may not be eliminated over the same time horizon. The balanced-approach strategy endorsed by the FOMC is consistent with the view that maximum employment and price stability stand on an equal footing as objectives of monetary policy.
Translation: "This is called squaring the circle."
As I see it, such a balanced approach has two important implications that deserve emphasis. The first is that, if the FOMC is doing its best to minimize deviations from its objectives, then, over long periods, both unemployment and inflation will be about equally likely to fall on either side of those objectives.
Translation: "Give us a break! Our theory doesn't work anymore. We need more time. We are doing our best. That's all you should ask from any government-created but unaudited bank cartel-enforcement agency."
The second property, which to me is the essence of the balanced approach, is that reducing the deviation of one variable from its objective must at times involve allowing the other variable to move away from its objective. In particular, reducing inflation may sometimes require a monetary tightening that will lead to a temporary rise in unemployment. And a policy that reduces unemployment may, at times, result in inflation that could temporarily rise above its target.
Translation: "Alan Greenspan taught me how to speak central bank Esperanto. I am getting pretty good at it, don't you think?"
Communicating the Economic Outlook and Its Policy Implications
How can we translate the principles embodied in the Committee's consensus statement of longer-run goals and strategy into a concrete plan of action for the current situation? And, having done so, how can we make such a plan understandable to the public?
Translation: "If this does not put you to sleep, nothing will."
At this point, she was halfway through. Then she hauled out graphs. She droned on and on and on explaining these graphs, mimicking a classic Bernanke speech. But he is lively compared to her -- a bundle of laughs.
Here is how she ended.
The past few years have seen important changes in the FOMC's communications--innovations that promote the Federal Reserve's accountability to the public. Beyond that, I believe better communication serves to improve the efficacy of monetary policy at a time when the FOMC faces constraints on its ability to provide appropriate support to the economic recovery through the federal funds rate, its traditional policy tool. In my view, we've made progress, but much work remains to be done.
Translation: "Mission accomplished. You people still can't find the pea under the shell. That's because there is no pea under the shell. We are making up policy as we go along. We haven't a clue as to what we're doing. All we have is Bernanke's old textbook. It isn't working. That is the central message of this speech."