Speech

After Greenspan: Whither Fed Policy? WesternEconomicAssociationInternationalConference(WEAI) SanFrancisco,California July6,2005 It is widely agreed that Alan Greenspan theGreenspanregime.Greenspandidnotachieve has been an outstanding Fed Chairman. instantaneousmarketconfidencewhenhetook Over the years ahead, Fed chairmen will officein1987,butbuiltthatconfidencequickly surely want to extend Greenspan’s record duringhisinitialyearsasFedchairman. of policy success. But I ask this question: What Examinationofcurrentsurveydataandthe are the characteristics of the Greenspan policy spreadbetweentheyieldsonconventionaland regime that have led to policy success? indexedTreasurybondsindicatesthatmarket AsfarasIknow,therehasbeennocompre- confidenceincontinuinglowinflationextends hensivestudyofthecharacteristicsofthe wellbeyondGreenspan’stenureasChairman. Greenspanregime.Toextendtheregimewill InstitutionalizingmarketconfidenceintheFederal requireanunderstandingofjustwhattheregime Reserveisagreataccomplishment.However,there is.Mypurposeistooutlinesomethoughtson isnodoubtinmymindthatincomingyearsthe thatissuebydiscussingfourkeycharacteristics marketswillbewatchingcloselytoseewhether oftheGreenspanregime.Firstonmylistislow- chairmenfollowingGreenspanwillmaintaina inflationcredibility—thatis,marketconfidence low-inflationregime.Inrecentyears,market thattheFederalReservewillconductpolicyto confidencehasbeensogreatthatonlyastringof yieldlowinflationaveragedoveranyspanofa poorpolicydecisionswouldhavechangedinflafewyears.Theotherthreecharacteristicsofthe tionexpectations.Forexample,inflationexpec- Greenspanregimearesuccessfulcrisismanage- tationshardlychangedintheaftermathof9/11 ment,empiricalunderstandingoftheeconomy, andoftheoilpriceincreasesof2004-05. andpredictabilityofmonetarypolicy.I’llcomment Thenextchairmanwillstartwithabaseof onallfour,butconcentrateonpredictabilityissues institutionalizedmarketconfidence,butthemarastheseare,Ibelieve,themostinterestingofthe ketwillnaturallybesomewhatskepticaluntil characteristicsoftheGreenspanregime. thenewchairmanhasestablishedhisorherown Beforeproceeding,IoffertheusualFeddis- trackrecord.Putanotherway,theFed’sinflationclaimer—thattheviewsIexpressdonotneces- fightingcredibilitymaybesomewhatmorefragile sarilyreflectofficialpositionsoftheFederal overthenextfewyearsthanithasbeenoverthe ReserveSystem.Ithankmycolleaguesatthe pastfewyears.Almostcertainly,futurechairmen FederalReserveBankofSt.Louisfortheircom- willaddresstheissueofwhethertheFederal ments,especiallyBobRascheandDanThornton, Reserveshouldadoptaformalinflationtarget, butIretainfullresponsibilityforerrors. whichmanyeconomistsandanumberofmembersoftheFOMC,includingme,haveespoused. LOW-INFLATION CREDIBILITY SUCCESSFULCRISISMANAGEMENT MarketconfidenceintheFederalReserve’s abilityandwillingnesstomaintainalowtrend Effectivecrisismanagementisimportantnot rateofinflationhasbeenacorecharacteristicof onlyfordealingwithcrisesbutalsoforinstilling 1

MONETARYPOLICYANDINFLATION marketconfidenceintheFederalReserve.Ibelieve Nevertheless,Greenspan’sownexpertisewillbe thattheFederalReservehasmanagedcrises hardtomatch. effectivelythroughoutthepost-WorldWarII period,butitsskillswerecertainlyhonedduring theGreenspanyears.Themajorcrisesduring PREDICTABILITY OF MONETARY theseyearswerethestockmarketcrashof1987, POLICY thefinancialmarketdisturbanceinthefallof TheGreenspanyearshaveseenahugechange 1998followingtheRussiandefaultandnearfailintheconductandtransparencyofmonetary ureofLongTermCapitalManagement,andthe policywiththeresultthatpolicyactionshave terroristattacksofSeptember2001.TheFedprebecomefarmorepredictabletothemarket.When paredcarefullyforY2K,anditspreparations Greenspantookofficein1987,theFeddidnot contributedtothateventpassingsmoothly.Ahead disclosepolicyactionsonacurrentbasis.Indeed, ofY2Kandespeciallyfollowing9/11theFed before1987Feddecisionswerenotonlymurky investedheavilyinstrongercontingencyarrangetothemarketbutattimesevenmurkywithinthe mentsforcommunicationsamongpolicymakers System,includingwithintheFOMC,asDaniel andininfrastructureformaintainingessential Thornton(2005)hasdocumented.Moreover, paymentssystemservices. beforeGreenspanmanywithintheFedbelieved Thelow-inflationenvironmentclearlymakes thatpolicyeffectivenessdependedontaking crisismanagementeasier.Forexample,theFed marketsbysurprise. createdahugeamountofliquidityfollowingthe Theevolutiontogreatertransparencypro- 9/11attacks,butdoingsodidnotraiseinflation ceededstepbystepduringtheGreenspanyears. fears.TheFedwithdrewtheextraliquidityas Themostimportantsinglechangewasthatthe marketsreturnedtonormal;theFed’shandling Fedbegantodiscloseitsdecisionsonthetarget ofthecrisisclearlyreducedtheimpactofthe fedfundsratein1994.Besidesdisclosureofpoleventontheeconomy. icyactions,twootherfeaturesoftheconductof Intheyearsahead,shouldtherebefurther policypromotedtransparency.Onewasthatthe crises,Ibelieveitisreasonabletoexpectproperly FOMCadjustedthetargetfedfundsrateinincrecalibratedresponsesbytheFed.Thelessonsof mentsof25basispointsandtheotherwasthat experiencehavebeenthoroughlyinstitutional- mostadjustmentsoccurredatregularlyscheduled izedinFederalReservepractice. FOMCmeetings.PooleandRasche(2000)documenttheimprovedpredictabilityofFedpolicy actions. EMPIRICAL UNDERSTANDING Clarityofmonetarypolicyhasbeenenhanced OF THE ECONOMY bythegeneralpatternofchangesinthetarget federalfundsrate.Tomakethispoint,consider AlanGreenspanhasanastoundingcommand policyactionsinapre-rationalexpectations ofdata.Hehasappliedtorawdataadeepunderoptimalcontrolframework.Insuchamodel,the standingofeconomictheoryandbusinesspractice centralbankwouldrespondcontinuouslytoarrivandthatunderstandinghasenabledhimto inginformation,adjustingthepolicyinstrument trackeconomicdevelopmentsingreatdetail. byvaryingamountsdependingonthenatureof Greenspan’shighlyinformedintuitionhasenabled theinformationandfrequentlychangingthe himtoadjustthestanceofpolicy—thesettingof directionofpolicyaction.Suchadjustmentscharthetargetfederalfundsrate—intimelyfashion. acterizeaircraftautopilots,forexample.During Tosomedegree,Greenspanhasinstitutional- theGreenspaneratheFedhasnotadjustedthe izedcommandoverdataintheFederalReserve’s targetfederalfundsrateinthisfashion.Acasual staff,especiallystaffattheBoardofGovernors. examinationofthetargetfundsrateserieswill 2

AfterGreenspan:WhitherFedPolicy? showlongstringswithoutchangeandlongstrings isconditionalontheinformationavailabletothe withchangesinthesamedirection.Short-run centralbankatthetimetheguidanceisissued, reversalshavebeenrelativelyrare.Ibelievethat thenmarketsshouldnothavedifficultyinunderthispatternofadjustmentprobablyenhances standinghownewinformationmightrequire marketunderstandingofthedirectionandpur- policyactionthatdiffersfromtheguidance. poseofpolicyactions,helpingtoimprovethe Experiencetodatewithforwardguidance predictabilityofpolicy.Whenthecentralbankis hasbeensuccessfulbutinmyopinionitistoo predictable,itcanbesomewhatinactiveasmarket earlytotellwhetherthisdeparturewillbesucresponsescarrymuchofthestabilizationburden. cessfulinthelongrun.Thematterwillbetested Startingwiththepolicystatementfollowing whenchangedcircumstancesrequirepolicy itsmeetingonAugust12,2003,theFOMCbegan actionthatdiffersfromforwardguidance. toprovidefirmguidanceastothefuturedirection Ibelievethatimprovedpredictabilityofpolicy ofpolicy.ThestatementsaidthattheCommittee hashadmuchtodowithimprovedeffectiveness “believesthatpolicyaccommodationcanbe ofpolicy.PooleandRasche(2000)arguethat maintainedforaconsiderableperiod.”Thislan- changesinpolicypracticehavemovedtheeconguagewasrepeateduntilthestatementreleased omytowardarationalexpectationsmacroecoonJanuary28,2004,whentheCommitteesaid nomicequilibriuminwhichtheFedandthe thatit“believesthatitcanbepatientinremoving marketsreactinsimilarfashiontothearrivalof itspolicyaccommodation.”Thatlanguagewas newinformation.Synchronizedresponses continueduntilMay4,2004,whentheCommittee betweenthemarketsandtheFedenhancethe saidthatit“believesthatpolicyaccommodation economy’sadjustmenttochangedcircumstances, canberemovedatapacethatislikelytobemeas- therebyincreasingeconomicstabilityandeffiured.”AtitsmeetingofJune29-30,2004,the ciency.Intheyearsahead,maintainingand Committeeraisedthetargetfederalfundsrateby extendingimprovedpredictabilityofpolicywill 25basispointsandissuedastatementrepeating beamajorchallengeforFederalReservechairmen. the“measuredpace”language.Thatlanguage I’vesketchedsomethoughtsonfourcharaccametobeinterpretedinthemarketascreating teristicsoftheGreenspanregime.Giventheeconanexpectationofanincreaseinthetargetfed omy’sexcellentperformanceduringtheGreenspan fundsrateof25basispointsatthenextFOMC era,furtherstudyoftheGreenspanregimeshould meetingand,dependingoncircumstances,atthe commandahighpriorityamongmonetaryeconnextseveralmeetings.Ateverysubsequentmeet- omists.Understandingthesourcesofsuccesswill ingfollowingtheJune2004meeting,throughits becriticaltocontinuingsuccessinfutureyears. mostrecentonJune29-30,2005,theCommittee raisedthetargetfundsrateby25basispointsand repeatedthe“measuredpace”language. REFERENCES Providingguidanceonlikelyfuturepolicy Poole,WilliamandRasche,RobertH.“Perfectingthe actionsisasignificantdeparturefortheFederal Market’sKnowledgeofMonetaryPolicy.”Journal Reserve.Historically,theFedandothercentral ofFinancialServicesResearch,December2000. bankshavebeenreluctanttoprovideforward guidanceoutofaconcernthatdoingsowould Thornton,DanielL.“ANewFederalFundsRate limitfreedomofactionintheeventofnewinfor- TargetSeries:September27,1982—December31, mationindicatingthatchangedcircumstances 1993,”FederalReserveBankofSt.LouisResearch calledforachangeinpolicydirection.Ifthemar- DivisionWorkingPaper2005-032A,May2005. ketshaveathoroughunderstandingofpolicy, includinganunderstandingthatforwardguidance 3