Washington – When the Federal Reserve’s policy-making committee meets on Tuesday and Wednesday, 5 of the 10 voting members will arrive in open disagreement with the chairman, Ben S. Bernanke, about the direction of monetary policy. Three conservative members say the Fed has already done too much. Two liberals say the Fed needs to do much more.
But it is still the chairman who determines whether the central bank should expand its campaign to stimulate growth for the third time since August, and lately Mr. Bernanke has been focused on an old theme: communicating the benefits of existing policies in order to increase their impact.
The Fed “continues to explore ways to further increase transparency about its forecasts and policy plans,” Mr. Bernanke said in a mid-October speech in Boston. Later he described improved communication as perhaps the main lesson that makers of monetary policy should take from the financial crisis.
The Fed is focused on communication because it wants to reduce long-term interest rates, which determine the cost of borrowing for businesses and consumers, but it exerts direct influence primarily on short-term interest rates. Long-term rates reflect expectations about the future path of short-term rates, so the Fed wants to convince investors that it will continue to hold short-term rates near zero.
The central bank also could expand its extensive portfolio of Treasury securities and mortgage bonds, putting direct downward pressure on long-term rates, but Fed officials are reluctant to do so in the face of considerable political opposition and technical concerns that the purchases would absorb too much of the available stock of securities, crowding out private investors.
Charles L. Evans, president of the Federal Reserve Bank of Chicago, has proposed that the Fed should announce temporary boundaries for inflation and unemployment, pledging to keep short-term interest rates near zero until the unemployment rate drops below 7 percent from its current level above 9 percent, or the medium-term outlook for the rate of inflation rises above 3 percent. It is now somewhat below 2 percent, the maximum rate the Fed views as healthy.
“Given how badly we are doing on our employment mandate, we need to be willing to take a risk on inflation going modestly higher in the short run if that is a consequence of policies aimed at lowering unemployment,” Mr. Evans said in a recent speech.
“The Fed has done a good deal of thinking out of the box over the past four years,” he said. “I think it is time to do some more.”
A growing number of economists outside the Fed have advocated the more aggressive approach of permanently changing the central bank’s focus, from the level of inflation to a broader measure of growth — the present value of economic output — that would similarly make clear that the Fed was willing to tolerate a higher level of inflation in the short term. That approach, however, has gained little traction within the central bank.
Janet L. Yellen, the vice chairwoman of the Fed’s board of governors, described Mr. Evans’s idea as “potentially promising” in a speech in Denver two weeks ago. “Such an approach could be helpful in facilitating public understanding of how various possible shifts in the economic outlook would be likely to affect the anticipated timing of policy firming,” she said.
But she added that the approach was “not without potential pitfalls.” In particular, Fed officials are concerned that targets would be seen as destinations, conveying that the Fed was comfortable with 7 percent unemployment or 3 percent inflation.
The Fed could formally fix the 2 percent rate as a long-term target for inflation, to underscore that the current measures are temporary. Mr. Bernanke has advocated that idea in the past, but as chairman he has hesitated to pull the trigger, in part because of concerns about the political consequences if formalizing an inflation target is seen as a disregard for unemployment.
Citing these concerns, several analysts said the Fed was likely to make a more modest shift in its approach, such as publishing a prediction of the level at which it expects to maintain short-term interest rates over the next several years, alongside existing predictions of the future path of economic growth, unemployment and the rate of inflation. That could give investors greater confidence that short-term rates will remain low.
“Communication is what monetary policy is fundamentally about,” said Laurence H. Meyer, a former Fed governor who heads the forecasting company Macroeconomic Advisers, arguing that such policies can have a greater impact than asset purchases.
Pushing back against such proposals are three presidents of regional Federal Reserve banks, concerned that the central bank already has damaged public perceptions of its commitment to maintain inflation at a low level.
“If this drift in inflation risk tolerance were to persist, or were expected to persist, it could give rise to a damaging increase in inflationary expectations,” one of the dissidents, Narayana Kocherlakota, president of the Federal Reserve Bank of Minneapolis, said earlier this month.
This position is embraced by many Republican members of Congress, and the candidates for the Republican presidential nomination, but the dissident Fed officials have not returned that embrace. Mr. Kocherlakota, in the same speech, described the Fed’s work as “a largely technocratic exercise that is fundamentally apolitical.”
In addition to Mr. Bernanke’s tolerance for public dissent — reflecting his belief, developed during his prior life as an academic, that central banks should operate more transparently — the fractious debate reflects the unusual challenges still confronting the Fed long after it expected to be on the road back to normalcy.
The Fed did not predict or prepare for the enduring economic malaise the country is now experiencing. Moreover, while Mr. Bernanke has led what is, taken all together, an unprecedented effort to spur renewed growth, at several points he has chosen to hesitate, avoiding the dangers of doing too much, only to find he had not done enough.
The Fed has twice paused its stimulus campaign, most recently in June, only to be forced back into action by evidence that growth once again was falling short of its predictions.
In August, the Fed announced its intention to maintain short-term interest rates near zero for at least two more years, provided that inflation remained low.
In September, at the committee’s most recent meeting, the members decided to further reduce long-term interest rates by shifting $400 billion from investments in short-term Treasury securities to longer-term Treasuries.
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