Speech

A Monetary Policymaker’s Perspective TheCatoInstituteBookForum Celebratingthe40thAnniversaryofthePublicationofAMonetaryHistoryoftheUnitedStates,1867-1960 (byMiltonFriedmanandAnnaJ.Schwartz,PrincetonUniversityPress,1963) Washington,D.C. November21,2003 It is an honor to participate in this event, policy.Badeconomicanalysiswillalmostcerrecognizing the enormous importance of tainlyproducebadmonetarypolicy.Thereal-bills the publication of the Friedman and doctrinehadalottodowiththeFederalReserve’s Schwartz’s Monetary History 40 years ago. catastrophicmistakesintheearly1930s.Later, I’ve been asked to focus on the policymaker’s beyondtheperiodcoveredbytheMonetary History,thetheoryofaPhillipscurvetradeoff perspective. However, I must emphasize that betweeninflationandunemploymentplayeda the views I express are those of a policymaker, similarroleinfosteringtheFed’sinflationary and do not necessarily reflect official positions mistakesofthe1960sand1970s.Soalsodid of the Federal Reserve System. neglectofthekeydistinctionbetweenrealand TheintroductiontotheMonetaryHistory nominalinterestrates. startswiththissentence:“Thisbookisaboutthe Thenationisaskingfortroubleifcentral stockofmoneyintheUnitedStates”(p.3). bankersarenotcurrentonthelatestdevelopments FriedmanandSchwartzshowconvincinglythat inmonetaryandmacroeconomics.By“current failuretopayattentiontomoneygrowthwasthe on”Icertainlydonotmean“automaticallyacceptsourceofmanypolicymistakes.Iconfesstofeeling.”Manycurrentdevelopmentscomingoutof ingveryuneasythatmoneyplayspracticallyno theacademicworldturnouttobewrong.Iam roleinpolicydiscussionsintheFederalReserve notcriticizingacademics;theessentialnatureof today.IamoneofthefewmembersoftheFOMC researchisasearchfordeeperunderstanding whoevermentionsmoneyduringthemeetings. andtheeffortinevitablyyieldsapproachesthat Despitethisobservation,thereisnodoubtthat sometimes,andevenfrequently,turnouttobe FriedmanandSchwartzhavetaughteveryoneto blindalleys. watchforwarningsignsfrommoneygrowth;if ThePhillipscurvetradeoffwasanimportant andwhenthosesignsappear,Iwillnotbethe exampleofawrongideathatgainedwideacceptonlyonetalkingaboutthem. anceandhadamajorimpactonmonetarypolicy. Fortunately,thebookisaboutalotmorethan Althoughignoranceofeconomicsisalikelyrecipe thestockofmoney.TheMonetaryHistoryisan forfailure,followingtheadviceofmainstream importantscholarlycontributionaboutU.S.eco- economicsishardlyaguaranteeofsuccess.The nomichistory,monetarypolicy,andthestockof Feddidfollowmainstreamadviceinthelate money.Therecanbenodistinctpolicymaker 1960sandmostofthe1970s,anditwasprecisely viewofthebook’simportancebecauseitbears thatadvicethatcreatedtheGreatInflation. onthemonetaryanalysisofbothacademicsand Thereisnosubstituteforsoundeconomics policymakers. astheunderpinningforsoundmonetarypolicy, PerhapsthemostimportantmessageItake butformeasapolicymakerthatfactcreatesa awayfromtheMonetaryHistoryisthetremen- profoundproblem.Iamnotalaymaneconomist, dousimportanceofideasinshapingmonetary butalongwithlaymenmustfindawaytosort 1

MONETARYPOLICYANDINFLATION outcorrectfromincorrectideaswhentheexperts lastingimportanceforthepracticeofcentral differ. banking. Academicscanhelpbyspeakingmoredirectly Ifcompetentleadershipisessentialtogood totheproblemspolicymakersface;frommyyears monetarypolicy,thenanaturalfocusisoninstiasbothanacademicandasapolicymaker,Ifind tutionalarrangementsthatmaximizethepotential thatacademiceconomistsareoftenoutoftouch forputtingcompetentleadersinofficeandensurwiththesituationfacedbypolicymakers.Iam ingthattheyhavethepoliticalfreedomtomanage policywisely.TheMonetaryHistorydoestreat particularlyannoyed,frankly,whenIhearacasomeissuesofinstitutionaldesign,especially demics’pleasformoreresearchwhenthatsolutheunsatisfactoryfeaturesoftheoriginalFederal tionissimplynotrelevanttoapressingneedto ReserveActthatcreatedanambiguousgovernance decideonewayortheotherrightnow.Iknowthat structurebetweentheFederalReserveBanks advancesineconomicscanhaveimportant andtheBoardinWashington.Legislationinthe policyimplications.Thoseadvanceswillregister 1930slargelyclearedupthisproblem.However,I morequicklyonactualpolicydecisionsifacadonotrecallmuchdiscussionintheMonetary demicsexplaintheirrelevanceastheymightif HistoryabouthowFedgovernorsandBankprestheyweresittingattheFOMCtableandhad identswereselected. responsibilityforpolicydecisions.TheMonetary Theissuesofinstitutionaldesignareimpor- Historyhasthatkindofrelevance,fortheanalysis tant,andareonmymindalot.Irecallthe canbebroughttobeardirectlyoncurrentdevelop- FriedmanandSchwartzdiscussionofhowthe mentsastheyunfold. Fed,intheearly1930s,engagedinexpansive Therehasbeenasubstantialchangeinatti- openmarketoperationsundercongressional tudeswithintheFederalReserveovertheyears. pressure,butceasedsucheffortswhenCongress IwasastaffmemberattheBoardofGovernors wentoutofsession.Unfortunately,itwouldnot intheearly1970sandrememberthevisceral bedifficulttofindahundredexamplesofbad negativereactionstomonetarismsoevidentin congressionaladviceforeveryexampleofgood manyseniorFedstaffmembersandgovernors.I congressionaladvice. donotseethoseattitudestoday.Fedpeopleare SincetheMonetaryHistory,theprofession muchmoreopen-mindedthantheyusedtobe, hasdevelopedaconsensusthatcentralbank andthatattitudeisextremelyhelpfultothecause independenceisabetterinstitutionaldesign thantightcontrolbythelegislativeorexecutive ofmakinggoodeconomicsbearonmonetary branchofgovernment.Itisinterestingtonote policy.TheFederalReserveasaninstitutionhas thattheFederalReserve,withReserveBankpreschanged;today,itinvitesopendiscussionandis identsappointedbytheboardsoftheReserve tolerantofdissentingviews. banks,hasagreaterprivatesectorinputthanany FriedmanandSchwartzareclearaboutthe othermajorpolicyinstitutionintheUnitedStates. importanceofgoodleadership.Indiscussingwhy Someviewthisstructureasantidemocratic,but Fedpolicywassoineptduringtheearly1930s, inmyviewthecurrentarrangementprovides theysay,“[t]hedetailedstoryofeverybanking clearpoliticalcontrolthroughtheBoardof crisisinourhistoryshowshowmuchdepends Governorswhiletheprivatesectorrolethrough onthepresenceofoneormoreoutstandinginditheReserveBanksmakestheinstitutionmore vidualswillingtoassumeresponsibilityand directlyaccountabletothebroadpublicinterest leadership”(p.418).Theyemphasizetheimpor- thanwouldbethecaseifallcontrolcamefrom tantroleplayedbyBenjaminStronginthe1920s Washington.Inanyevent,issuesofinstitutional andthevoidleftbyhisdeathin1928.Theleader- designwerepartoftheanalysisintheMonetary shipofPaulVolckerandAlanGreenspanmade HistoryandwhatFriedmanandSchwartzsay anenormousdifferencetooutcomesoverthe abouttheseissuesishighlyrelevanttodebates lastquartercenturyandtheirexamplewillhave today. 2

AMonetaryPolicymaker’sPerspective Oneofmyspecialinterestsistheroleof expectationsinshapingeconomicdevelopments. FriedmanandSchwartzdiscussexpectationsin anumberofcontexts.Oneoftheseconcernsthe effectsofanticipationsofadepressionfollowing WorldWarII.Today,ourknowledgeofexpectationsisvastlysuperiortothedataavailablefor theperiodcoveredbytheMonetaryHistory.We haveextensivesurveydataonexpectationsabout awidevarietyofeconomicvariables.Moreimportantly,wehaveexcellentmarketdataoninflation expectations,fromtradinginindexedbonds,data onoilpriceexpectationsfromtradinginlong-term oilpricefutures,anddataonmonetarypolicy expectationsfromthefederalfundsfuturesmarkets.Datafromderivativesmarketspermitcalculationsofriskassessmentsinmanymarkets. Dataonexpectationscertainlymakethelifeofa policymakeraloteasier. Iwonder,though,towhatextentthebehavior oftheeconomyitselfhaschangedasaconsequenceoftheproliferationoffinancialinstruments.Certainly,behaviorinmanyindividual marketshaschanged,butasfarasIknowwedo nothavereliableestimatesofeffectsonthemacroeconomy.Thisisanimportantissue,asachangingeconomicstructuredegradesthevaluefor currentpolicyofexperienceinearliereras. I’llfinishbyreturningtomymainpoint, whichistheimportanceofgoodeconomicsfor goodmonetarypolicy.Athemerunningthrough theMonetaryHistoryisroleofinflationinthe businesscycle.TheFederalReservehasfinally beensuccessful,atleastforthemoment,instabilizingthepricelevel.Dependingonyourviewas tothebiasinpriceindexes,therateofinflation todayiszerooronlyslightlyabovezero.The FriedmanandSchwartzworkdemonstratesthat pricestabilitywasachievedmomentarilyanumberoftimesinU.S.history,butthatblissfulstate wasneverlasting.IamacutelyawareofthathistorytodayandhopethattheFederalReserve’s recentsuccessincreatingpricestabilitycan becomeapermanentfeatureoftheeconomy. Ourhistorymakesclearthatpricestabilityisnot automatic. 3