WASHINGTON (MNI) – The following are excerpts from the Philadelphia
Federal Reserve Bank’s 2010 Annual Report “Navigating Change,” featuring
President Charles Plosser’s essay “The Scope and Responsibilities of
Monetary Policy.” In this essay, President Plosser discusses the
appropriate scope of monetary policy in dealing with real economic
fluctuations, asset-price swings, and the allocation of credit:
“… we are in danger of assigning to monetary policy a larger role
than it can perform, in danger of asking it to accomplish tasks that it
cannot achieve, and, as a result, in danger of preventing it from making
the contribution that it is capable of making.”
Milton FriedmanThese words are taken from the presidential address
of the distinguished economist and Nobel Laureate Milton Friedman to the
American Economic Association in 1967.1 Although the message was
delivered over 40 years ago, I believe Friedman’s caution is one well
worth remembering, especially in this world where central banks have
taken extraordinary actions in response to a financial crisis and severe
recession. I believe policymakers and the public need to step back from
our focus on short-term fluctuations in economic conditions and to think
more broadly about what monetary policy can and should do and in the
process adjust our expectations of what we believe to be the scope and
responsibilities of our central bank.
…
I believe we have come to expect too much from monetary policy.
Indeed, broadening monetary policy’s scope can actually diminish its
effectiveness. When monetary policy overreaches and fails to deliver
desired, but unattainable, outcomes, its credibility is undermined. That
makes it more difficult to deliver on the one goal that monetary policy
is actually capable of meeting. Moreover, when the central bank is asked
to implement policies more appropriately assigned to fiscal authorities,
the independence of monetary policy from the political process is put at
risk, which also undercuts the effectiveness of monetary policy.
…
Let me be clear that this does not mean that monetary policy should
be unresponsive to changes in broad economic conditions. Monetary
policymakers should set their policy instrument the federal funds rate
in the U.S. consistent with controlling inflation over the
intermediate term. So the target federal funds rate will vary with
economic conditions. But the goal in changing the funds rate target is
to maintain low and stable inflation. This will foster the conditions
that enable households and businesses to make the necessary adjustments
to return the economy to its sustainable growth path and to long-run
maximum employment. Monetary policy itself does not determine this path,
nor should it attempt to do so.
…
So what should monetary policy do? To strengthen the central bank’s
commitment to price stability, I have long advocated that the Federal
Reserve adopt and clearly communicate an explicit numerical inflation
objective and publicly commit to achieving that objective over some
specified time period through a systematic approach to policy. It is one
of the messages of economic research over the last 40 years that policy
is best conducted in a rule-like manner. This systematic approach helps
promote more effective communication so that the public and the markets
will understand and better predict how policy will evolve as economic
conditions change. This, in turn, helps reduce economic volatility and
makes policy more effective in achieving its long-run goals.
Indeed, the Federal Reserve is one of the few central banks among
the major industrialized countries that have not made such a public
commitment to a numerical inflation objective. I believe it is time we
did. Such a commitment will help the public form its expectations about
monetary policy, which would enhance macroeconomic stability.
…
A body of empirical research indicates that when central banks have
a degree of independence in conducting monetary policy, more desirable
economic outcomes usually result. But such independence can be
threatened when a central bank ventures into conducting fiscal policy,
which, in the U.S., rightly belongs with Congress and the executive
branch of government. Having crossed the Rubicon into fiscal policy and
engaged in actions to use its balance sheet to support specific markets
and firms, the Fed, I believe, is likely to come under pressure in the
future to use its powers as a substitute for other fiscal decisions.
This is a dangerous precedent, and we should seek means to prevent such
future actions.
…
Like Milton Friedman in an earlier time, I too am concerned that we
are in the process of assigning to monetary policy goals that it cannot
hope to achieve. Monetary policy is not going to be able to speed up the
adjustments in labor markets or effectively burst perceived asset
bubbles, and attempts to do so may create more instability, not less.
Nor should monetary policy be asked to perform credit allocation in
support of particular sectors or firms. Expecting too much of monetary
policy will undermine its ability to achieve the one thing that it is
well-designed to do: ensuring long-term price stability. It is by
achieving this goal that monetary policy is best able to support full
employment and sustainable growth over the longer term, which benefits
all in society. Although Friedman’s words were spoken more than four
decades ago, policymakers would do well to heed his insights, which
remain particularly relevant for our times.
** Market News International Washington Bureau: 202-371-2121 **
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