A Vision In Sharper Focus
Thursday, November 15, 2007
Since its founding 94 years ago, the Federal Reserve has generally kept quiet about just how fast its leaders think the economy can grow or what inflation level they are okay with.
No longer. Beginning Tuesday, the Fed will share more detailed and more frequent projections about the economy than it has in the past, Chairman Ben S. Bernanke said in a speech here yesterday, a change that may provide strong clues about the Fed's target levels of inflation.
By making the Fed's actions more predictable, it would be easier for businesses and consumers to plan financial decisions, Bernanke said. Moreover, he said, financial markets would respond to economic news in ways that are more likely to reinforce the Fed's actions.
"This is opening the kimono more so that people who are not in the [policymaking] meeting can see the range of forecasts," said Alan S. Blinder, an economist at Princeton and a former Fed vice chairman.
The move is the latest in a series of steps to make it clearer to the public what the central bank is doing and why. As recently as 1994, the Fed did not make any announcement when it increased or cut short-term interest rates, its main policy tool. Savvy analysts had to discern whether the Fed had taken action based on activity in financial markets.
Analysts saw the speech as Bernanke's biggest step to date to leave an imprint on how the central bank operates. Bernanke, in his address at the Cato Institute, said the changes "represent just one more step on the road toward greater transparency at the Federal Reserve."
Four times a year the Fed will release reports of what 19 policymakers -- seven governors and 12 regional bank presidents -- expect in terms of inflation, economic growth and unemployment over the next three years. It will also publish a narrative explaining their consensus view on what major risks the economy faces.
That may sound like a subtle change from the current policy, in which forecasts are released twice a year for the ensuing two years. But the additional information is more significant than it may first appear.
With frequently updated information on Fed officials' expectations for the somewhat distant future, analysts will be able to discern what those officials think is the optimal level of inflation and what levels of growth and unemployment the United States is capable of maintaining.
"Guys in my business are going to figure out pretty fast that the projections for that third year are the Fed's target," said Ethan Harris, chief U.S. economist at Lehman Brothers.
In that sense, the new strategy has echoes of "inflation targeting," an approach to setting monetary policy that Bernanke advocated during his long academic career. In such a system, used by the Bank of England and in many other countries, policymakers agree to a common goal for inflation -- say, 1.5 percent -- and raise or lower interest rates to try to keep prices rising at that level.
That approach, Bernanke has argued, would allow consumers and businesses to keep their expectations of future inflation steady . That is important because inflation expectations can be self-fulfilling; when workers expect prices to rise, they demand higher wages, and retailers are able to increase prices.