By Neil Irwin
Washington Post Staff Writer
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.
Some Fed leaders, notably former chairman Alan Greenspan, have been wary of inflation targeting, arguing that it might limit the Fed's flexibility to deal with threats to the economy. On Capitol Hill, critics have said it would lead the Fed to focus only on holding down inflation, giving short shrift to the Fed's other mandate -- keeping unemployment low.
With its new policy, the Fed is not setting a single inflation target, but is effectively publishing information about each policymaker's preferred target. Nicolas Checa, a managing director of Kissinger McLarty Associates, said Bernanke was "adapting traditional inflation targeting to the realities of the Fed's mandate and the U.S. economic situation."
Without tipping his hand, Bernanke seemed to indicate that a more explicit form of inflation targeting continues to be a possibility down the road. "The communications strategy of the Federal Reserve is a work in progress," he said in his speech. Fed leaders "will continue to look for ways to improve the accountability and public understanding of U.S. monetary policy making."
Blinder said, "For my money I wish they would just blurt out what their inflation target is. But this is the moral equivalent of blurting it out."
The new policy is the first major change to how the Fed communicates with the outside world that Bernanke has undertaken as chairman; he has indicated that greater openness is among his foremost goals. Greenspan took several such steps in his 19 years as the top central banker, including releasing a statement explaining the Fed's thinking after each policymaking committee meeting, a practice that began in 2000.
"The difference between Greenspan and Bernanke is Bernanke is leading the push rather than being pulled along by it," Harris said.
This particular policy change was led by Vice Chairman Donald L. Kohn, a veteran of the central bank who has long been viewed as a skeptic of inflation targeting, but has signaled more openness in recent months.
Bernanke does not tip his hand about whether he is inclined to raise or cut interest rates. But he has been highly open, in speeches and congressional testimony, about sharing his views on the underlying state of the economy.
And he uses clear, direct language when speaking publicly, in contrast to the circumlocution that Greenspan often employed, by his own admission, to obfuscate his message. Bernanke has even allowed his sense of humor to show through.
For example, as he took a few questions after his speech yesterday, an audience member began by saying he had never asked a question of a Fed chairman before.
"Don't blow it," he said.