News Analysis: A Federal Reserve That Is Focused on the Value of Clarity

WASHINGTON

The Federal Reserve’s decision on Wednesday to announce specific economic objectives for its policies would have stunned and dismayed earlier generations of central bankers, who regarded secrecy as a virtue and obfuscation as a prized technique for manipulating financial markets.

“Since I’ve become a central banker, I’ve learned to mumble with great coherence,” Alan Greenspan, a former Fed chairman, told reporters in 1987. “If I seem unduly clear to you, you must have misunderstood what I said.”

But a greater appreciation for the virtues of transparency has been one of the most important shifts in central banking in recent decades. It is a response to public demands for increased accountability and an embrace of economic research on monetary policy that finds speaking clearly is more effective than mumbling. The Fed’s vice chairwoman, Janet Yellen, last month described the result as a “revolution.”

Until recently, the Fed under Mr. Greenspan and his successor, Ben S. Bernanke, were tentative participants in this revolution. Mr. Bernanke spoke often about the need to speak clearly, but there were few tangible changes.

It now appears that he was simply busy dealing with a financial crisis. Over the last two years, Mr. Bernanke and his colleagues have announced a series of changes intended to increase the transparency of the Fed’s decision-making. Some of those moves have also transformed the way those decisions are made and, the Fed hopes, increased the power of its efforts to revive the economy.

Several of those changes were tied together by Wednesday’s announcement that the Fed would hold short-term interest rates near zero as long as the unemployment rate remained above 6.5 percent and inflation remained under control.

The new policy quantifies the goals that the Fed formally articulated for the first time in a statement in January. It extends the Fed’s recent willingness to forecast the level of interest rates. It will require the Fed to publish a consensus forecast of inflation for the first time. And it was announced on Wednesday, Mr. Bernanke said, in part because he was scheduled to hold a news conference, another of his innovations.

The Fed’s push to speak more clearly is partly motivated by political considerations. During the prosperous 1990s, the success of monetary policy was its own justification. After a financial crisis that the Fed failed to avert or predict, in the fourth year of a recovery that continues to disappoint, the Fed has no better defense than to explain what it is doing as clearly as possible.

It is primarily the result, however, of taking research seriously. While some economists, notably Milton Friedman, long argued that transparency would fortify the Fed’s independence, the economic case crystallized more recently.

“It was an article of faith in central banking that secrecy about monetary policy decisions was the best policy,” Ms. Yellen recalled in a recent speech.

Absurd as it may seem now, until the mid-1990s, the Fed did not announce changes in its benchmark interest rate. It let the movement speak for itself.

Ms. Yellen and her colleagues have now concluded that transparency actually enhances the impact of the Fed’s policies, particularly in the current circumstance. The Fed cannot push short-term rates below zero, but it still can reduce long-term rates, which are based on the expected level of short-term rates over the life of a loan, by persuading investors that those rates will remain near zero.

The Fed first experimented with this approach in 2003, when it announced that it would keep its benchmark rate at 1 percent for a “considerable period.”

In recent years, since pushing rates nearly to zero in December 2008, the Fed has steadily elaborated on that idea. It promised to keep rates near zero for an “extended period.” Then it announced a series of specific timetables, most recently promising in September to hold rates near zero at least until mid-2015.

Mr. Bernanke said on Wednesday that he did not expect the change to an unemployment rate peg to have a significant short-term impact. The Fed still expects to start raising rates no earlier than the second half of 2015. For now, the central bank is simply clarifying its reasons.

Article source: http://www.nytimes.com/2012/12/14/business/economy/a-federal-reserve-that-is-focused-on-the-value-of-clarity.html?partner=rss&emc=rss