By Steven K. Beckner

(MNI) – As the Federal Reserve’s policymaking Federal Open Market
Committee begins two days of meetings Tuesday, the Shadow Open Market
Committee urged the FOMC to “clarify its objectives.”

The SOMC, a group of monetary economists which has been giving
often pointed advice to the FOMC since 1973, urged Fed Chairman Ben
Bernanke to announce a formal inflation target at his Wednesday
afternoon press conference.

A growing number of Fed officials have advocated adoption of an
explicit, numerical inflation target, as indeed Bernanke himself did
before he became Chairman in 2006. But the FOMC has thus far avoided
doing so, perhaps out of concern that it would meet with objections from
Congress.

The Shadow group also called for a more rigorous assessment of the
goals and actual results of the Fed’s second, $600 billion round of
asset purchases or “quantitative easing.” An assessment of “QE2″ is
needed as a “benchmark” for a potential “QE3,” they said in a statement.

The economists said Bernanke needs to urge Congress and the
administration to uphold the “full faith and credit” of the U.S.
government and avoid a default on U.S. Treasury debt. And they said
Bernanke should inform the public of the Fed’s plans for dealing with
the consequences of a possible Greek debt default.

The SOMC advised the FOMC to be mindful of the limits on what the
Fed can accomplish within its dual mandate to pursue both price
stability and maximum employment. The Fed can control inflation, but not
unemployment, it maintained.

Pointing to the FOMC’s own projections of sluggish growth and high
unemployment, the Shadow economists state, “These sobering projections,
in light of the Fed’s unprecedented expansive monetary, credit, and
interest rate policy since the crisis began, are testimony to the limits
of what monetary policy can achieve in generating economic growth and
jobs in the medium to long term.”

The Committee is made up of Rutgers University Professor Michael
Bordo, Columbia University Professor Charles Calomiris, Carnegie-Mellon
University Professors Marvin Goodfriend and Bennet McCollum, Claremont
McKenna College Professor Gregory Hess; Bank of America Chief Economist
Mickey Levy and Anna Schwartz, a member of the National Bureau of
Economic Research and long-time colleague of the late Nobel Prize
winning economist Milton Friedman.

Their statement praised Bernanke for initiating quarterly,
post-FOMC press conferences as a welcome step toward greater
transparency, but observed that “communication cannot substitute for a
lack of clarity about objectives or about plans for realizing those
objectives.”

The SOMC recommended that the Fed “continue to clarify its
objectives and guidelines as follows to facilitate communication with
the media and the public via the Chairman’s press conferences.”

First of all, they urged Bernanke to “formally announce the FOMC’s
commitment to an explicit ‘mandate-consistent’ rate of inflation that it
uses as its long run objective for its policy deliberation.”

“At the same time, the Fed should articulate its strategic
framework for credibly delivering a low inflation environment based upon
the view stated by Chairman Bernanke at the April 27th, 2011 press
conference that, ‘In contrast to economic growth and unemployment, the
longer-run outlook for inflation is determined almost entirely by
monetary policy.'”

The SOMC said Bernanke “should also specify the Fed’s method for
measuring progress towards its inflation mandated target and over what
time horizon it wishes to meet this target.”

“It is long overdue for the FOMC to adopt a credible inflation
targeting framework,” the statement asserted, adding that the FOMC
should “formally and unilaterally adopt a priority for targeting low
inflation as necessary ‘operationally’ to achieve best outcomes for both
inflation and unemployment over the longer run.”

“We believe that such a step, while potentially controversial,
fulfills the Fed’s obligation to the dual mandate since only by creating
a low inflation environment can the Fed create the environment for
maximum employment,” they declared.

Anticipating the objections of some legislators who have maintained
that an inflation target would have to be accompanied by an unemployment
target, the SOMC said, “The current high unemployment rate in the U.S.
primarily reflects structural issues that are beyond the Fed’s
limitations, which draws attention to the need for clarification of the
dual mandate.”

A growing number of Fed officials have come around to the view that
an inflation target would be desirable, partially as a means of
anchoring vital inflation expectations. Most recently, Atlanta Federal
Reserve Bank President Dennis Lockhart did so.

Lockhart, who will be a voting member of the FOMC next year, said,
“Now is a good time to reaffirm in explicit terms the central bank’s
commitment to delivering its piece of the package of fundamentals needed
to assure a durable and lasting recovery.”

Lockhart said an inflation target should be “stated in terms of
some measure of overall, or headline, inflation;” must be “achievable
over a realistic timeframe,” and should allow for “short-run deviations
from the targeted rate of headline inflation.”

St. Louis Fed President James Bullard and Cleveland Fed President
Sandra Pianalto have also recently spoken in favor of an inflation
target.

The SOMC’s second recommendation was that “the Fed should provide
both a thorough self-assessment as well as welcome an independent
assessment” of QE2. It suggested such an assessment would not have
favorable results.

“The Fed justified QE2 by indicating it would lower long term
interest rates, prevent the threat of deflation, and address the rise in
the unemployment rate that was largely cyclical in nature, suggesting
insufficient demand in the economy,” the statement said. “These claims
should be evaluated in light of the historical experience: an initial
rise in long term rates, an unchanged employment picture, a modest rise
in headline inflation, and an increase in excess reserves held at the
Fed that is almost as large as QE2 itself.”

The SOMC said “a thorough post-evaluation of QE2 will help inform
the Fed’s eventual exit from its balance sheet expansion. Similarly, it
could also inform a potential further expansion of its balance sheet in
any subsequent QE3.”

“Indeed, should the FOMC consider at some point in the future to
further increase its balance sheet by purchasing additional government
securities, lessons learned, even unpleasant ones, will provide a
benchmark for sizing QE3 as well as the wisdom for conducting such
operations,” it added.

As Democrats and Republicans wrestle over conditions for extending
of the federal debt ceiling, the SOMC urged Bernanke to “articulate why
a Treasury default should be one of the last options ever undertaken by
the US government, and the likely consequences that any deterioration of
the status of U.S. Treasuries would have on financial markets, financial
firms, and our economic well being.”

Bernanke has done just that on several occasions.

Finally, the SOMC said Bernanke “should address what plans the Fed
has in place to deal with the ongoing financial crisis in Europe that
stems from the possibility of a sovereign debt default or restructuring
by Greece and potentially other countries.”

“For instance, what arrangements has the Fed made with the European
Central Bank and other Central Banks to address future financial and
credit market reactions to the European situation?” they asked.

And “given that any re-structuring or default on European sovereign
debt will trigger large gains and losses in the market for credit
default swaps, the Fed should explain what oversight they have put in
place to insulate US financial firms it oversees from this exposure.”

** Market News International **

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