The Fed's Bright Idea
Bernanke Wants to Shed More Light on How Agency Sets Monetary Policy

By Nell Henderson
Washington Post Staff Writer
Tuesday, March 28, 2006

Federal Reserve officials will conclude their policymaking meeting today by carrying on a practice that former chairman Alan Greenspan began as a radical innovation 12 years ago. They will tell the world what they have decided to do with short-term interest rates.

And if the Fed's new chairman, Ben S. Bernanke, has his way, central bank officials also will agree today to explore several possible ways to publicly communicate much more in the future about how they view the economy, the inflationary risks and the likely path of interest rates.

"Under Chairman Greenspan, [Fed] policy has become increasingly transparent to the public and the financial markets, a trend that I strongly support," Bernanke told Congress at his confirmation hearing in November. "I expect going forward to look for other opportunities to increase the transparency of the Federal Reserve."

No TV cameras at Fed policymaking meetings, Bernanke assured lawmakers. Wouldn't want to get carried away.

But the options Bernanke and his colleagues have floated include several practices employed by central banks in other countries. They include:

· Writing lengthier statements after policymaking meetings to explain their actions. Fed officials' last statement, released after their Jan. 31 session, included five sentences on their view of the economy and expectations for interest rates. In comparison, New Zealand's central bank released a 40-page document of analysis, data, discussion and forecasts after its March 9 meeting.

· Providing more descriptive minutes of their meetings. The minutes now are highly stylized summaries, former Fed officials say.

· Publishing more frequent economic forecasts by Fed policymakers, who now issue them twice a year.

· Holding news conferences after Fed meetings.

· Setting a long-term, numerical target for inflation. The Fed, by law, seeks "price stability," which generally translates as low inflation but is not specifically defined. Bernanke has proposed that the Fed say it will try to keep consumer price increases, excluding those for food and energy, within a range of 1 to 2 percent a year over a period of years.

The Fed's top policymaking group, the Federal Open Market Committee, is unlikely to adopt such major changes at its meeting today -- Bernanke's first as chairman. In the past, Greenspan assigned small working groups of FOMC officials the job of analyzing options and making recommendations for changes in Fed communications practices. Bernanke could do the same today.

Fed officials have resisted these proposals in the past, with several arguing that their current communications policy is working just fine.

But Bernanke has long argued that the U.S. economy benefits when the Fed is more open about how it makes monetary policy, which is the use of interest rates to keep inflation low and to support healthy employment growth.

The Fed's primary lever is its benchmark federal funds rate, the rate charged by banks on overnight loans, which influences many other interest rates in the economy. The benchmark rate directly influences other short-term rates, such as the prime rate on business loans and consumer loans linked to the prime.

However, monetary policy's bigger influence on the economy flows from its effects on long-term borrowing costs, such as rates on mortgages and corporate debt, which affect the prices of stocks, bonds, real estate and other assets. And long-term rates reflect financial markets' expectations of the path of short-term rates over time.

Financial markets can better anticipate future Fed interest rate moves if they understand the Fed's goals and strategy, Bernanke has said. That, in turn, will make monetary policy more effective, he argues.

But don't expect rapid change at the Fed. After all, Greenspan had been chairman more than six years before he proposed in February 1994 that the FOMC publicly announce its decision to raise interest rates. Before that, analysts and traders had to scrutinize arcane market data to divine whether the Fed had shifted policy.

As late as October 1993, Greenspan told FOMC members that an immediate announcement of interest rate decisions "could threaten to roil markets unnecessarily," a transcript shows.

Even when they first agreed in 1994 to reveal their decision, Greenspan and his colleagues insisted they were not establishing a precedent, according to another meeting transcript.

But that act did shatter the Fed's previous penchant for secretiveness and marked the first in a series of steps over the following 11 years that shed gradually more light on the central bank's actions and deliberations.

"It is no exaggeration to say that the FOMC's disclosure policies today bear no resemblance whatsoever to its policy of stone-walling prior to February 1994," wrote Princeton University economists Alan S. Blinder and Ricardo Reis in a paper on Greenspan's legacy presented at a Fed conference in August. "Were it not for the fact that the Fed took over 11 years to get from there to here, we might call these changes revolutionary."

"When it comes to transparency, the Greenspan Fed has been more of a laggard than a leader among central banks," they wrote.

It was not until 1999 that the FOMC agreed to issue a statement after every meeting and not until 2002 that the committee began revealing how individual members voted on a decision. Even now, if a committee member dissents at a meeting, that information is reported without any explanation of the dissenter's reasons.

Since August 2003, the FOMC statement has included language indicating the committee's likely future actions in a general way. At that time, the committee began saying it believed it would hold its rate at an unusually low 1 percent "for a considerable period" to signal that it would not start raising the rate as soon as economic growth picked up.

By May 2004, the FOMC was flashing the signal that it would start raising the benchmark interest rate slowly, saying it would do so "at a pace that is likely to be measured."

The FOMC raised the benchmark rate to 1.25 percent at its meeting in June 2004. It has increased it by a quarter of a percentage point at each of 13 meetings since then, to 4.5 percent at its last meeting, Jan. 31 -- Greenspan's last day as chairman.

The committee indicated in its January statement that more rate increases might lie ahead, saying, "some further policy firming may be needed." Bernanke, who became chairman Feb. 1, repeated that phrase in his Feb. 15 testimony to Congress and noted the economy's "considerable momentum," causing financial markets to anticipate another quarter-point rate increase today, and probably another in May.

Greenspan's communications legacy is "not that he will leave behind an unusually open central bank," Blinder and Reis wrote. "It is, instead, the unmistakable trend toward transparency that he has followed for eleven years. . . . And while the pace has rivaled that of a snail, none of those changes would have happened without Greenspan's backing."

Blinder served as vice chairman of the Fed under Greenspan from 1994 to 1996 and has worked with Bernanke, a former chairman of Princeton's economics department.

"Being opaque came naturally to [Greenspan], that's just the way he is," Blinder said in a recent interview. "Being more open and clear comes naturally to Ben, and I expect we'll see that continue."

To Blinder, for example, the FOMC's last statement reflected Greenspan's style -- cryptic, coded and generally impenetrable to a normal person. In contrast, he predicted one of the first acts of the Bernanke Fed will be to "adopt English as its official language. That itself would be a positive step."

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