Reuters Insider - Plosser calls for single Fed focus on inflation
14/11/2013 21:53
Click the following link to watch video:
http://insider.thomsonreuters.com/link.html?cn=share&cid=1157110&shareToken=Mzo2NjM0Yjc4Mi1kYmEyLTQ1ODgtYTJkYi0zMGJhZDEzNzAyY2I%3D&playerName=ReutersNews
Source: Thomson Reuters
Description: Philadelphia Fed President Charles Plosser,
speaking at a monetary policy conference sponsored
by the Cato Institute, said the Fed's mandate
should be redefined to focus on price stability.
(To access all exclusive Reuters Insider programming visit: http://insider.thomsonreuters.com)
Short Link: http://reut.rs/1iciCWu
Transcript (May be auto-generated)
Jim -- that Cato institute for inviting me to speak once again here at this prestigious. Annual monetary conference. So when Jim told me that this year's conference title was the -- a good idea. Must confess I was -- where. I noticed that I was the only sitting central banker on the program. And I didn't know whether it be flattered or. But nonetheless as Jim said the Fed is approaching its hundredth anniversary. And I think it is entirely appropriate reflect on its history and its future. To bat I plan to
discuss what I believe the Federal Reserve's essential role is and consider how it might be improved as an institution. And before I began I have to use the have to apply the usual disclaimers. That my views are not necessarily those of the Federal Reserve System or my colleagues on the Federal Open Market Committee. And they are eternally grateful when I make that statement. So. Doug north was that cold winner in 1993. Of the Nobel prize in economics. And he earned it for his work on the role of
institutions. North argued that institutions were deliberately devised to constrain interactions among parties both public and private. In the spirit of north work when theme of my talk today will be the institutional structure central banks. The central bank's goals and objectives its framework for implementing policy. And its governance structure. All affect it's performance. Central banks have been around for a long time they have clearly evolved over time is economies involved and governments have
changed. Most countries today operate under a Fiat money regime which the nation's currency has bad news. Because the government says it does. Central banks usually -- given the responsibility to protect or preserve the value of the purchasing power. That Fiat currency. Now in the United States the Fed does so by buying or selling assets in order to manage the growth of money and credit. The ability to buy and sell assets gives the Fed considerable power. To intervene in financial markets have only to the
quantity of these transactions but also for the types of assets you can buy and sell. That's entirely appropriate. The government to establish their central bank's -- limits. And constrain the actions of the institution to one degree or another. Yet in recent years we've seen many in both the explicit and implicit limits on central banks pushing their limits. The Fed and many other central banks have taken extraordinary steps to address the global financial crisis and the ensuing recession. These steps have
challenged the accepted boundaries of central banking and in both applauded. And announced. For example the -- adopted unconventional large scale asset purchases to increase accommodation. After reduce the conventional policy tool the federal funds rate to near zero. These asset purchases that led to the creation of trillions of dollars of reserves in the banking system and greatly expanded the Fed's balance sheet. But the Fed has done more than just purchase lots of assets. It is also are also altered the
composition. Of its balance sheet to the types of assets -- purchased. I've spoken a number on a number of occasions about my concerns that these actions to purchase specific. Non treasury assets amount to a form of credit allocation. Which target specific industries. Sectors -- firms. These credit policies crossed the boundary in my view from monetary policy in venture into the realm of fiscal policy. I included this category purchases the purchase of mortgage backed securities. As well the emergency
lending done under sixteen section thirteen 03 at the Federal Reserve act. In support the bailouts most notably of Bear Stearns and yeah -- Regardless for the -- rationale for these actions one needs to consider. The long term repercussions of such actions in what they may have for the Central Bank as an institution. As we contemplate what the -- the future should look like. I want to consider whether constraints on its goals might help limit the range of objectives it could use to justify it's actions.
Also consider restrictions on the types of assets can purchase to limit its interference with the market allocation of scarce capital. And that's generally to avoid engaging in actions that are best left of the fiscal authorities or the markets. Finally I'll also touch on governance and accountability of our institution in ways to implement policies that limit discretion. And improve both outcomes. And accountability. So we begin by addressing the goals and objectives for the Federal Reserve. These evolved
over time when the Fed was first established in 1913. US in the world -- operating under -- classical gold standard. Therefore price stability was not among the stated objectives of the federation and the original Federal Reserve act. Indeed the primary objective in the preamble -- provide as Jim said elastic currency. The gold standard has some very desirable features. Domestic and international legal commitments. Regarding convert ability were important disciplining devices. They were essential to the
regime's ability to deliver price stability. The goal -- was -- de facto rule. That most people understood and it allowed markets to function more efficiently because the price level was mostly stable regime. International gold standard began to unravel and was abandoned during World War I. After the war best efforts to reestablish parity prove disruptive and costly both economically. And politically. Attempts to reestablish the gold standard. Fell apart completely in the 1930s. As a result most the world
now operates under Fiat money Regina I said which is made price stability in important priority for those central banks. And and charged with -- ensuring the purchasing power their currency. Congress established the current set of monetary policy goals in 1978. Emitted Federal Reserve act specifies that the Fed. Here I'm quoting from the Federal Reserve act shall -- maintain long run growth. -- money and credit aggregates. Commensurate. With the economy's long run potential to increase production. Tour to
promote effectively the goals of maximum employment price stability and moderate long term interest rates and -- Just moderate long term interest rates are usually the result when prices are stable in the economy is operating your full employment many of interpret these goals as the dual mandate. With price stability and maximum employment is the focus. Let me point out that the instructions for congress call for the -- and -- -- -- Long term growth of money and credit. With the economies. Long run.
Potential. And there are many other things congress could upset. But it didn't. The fact. They -- doesn't talk about managing short term credit allocations across sectors doesn't mention inflating housing prices or other assets. It also doesn't mention anything about reducing short term fluctuations in employment. Many discussion about the discussion about the Fed's mandate seem to forget or at least overlooked. Its emphasis. On the long run. The public perhaps even some within the -- have come to accept
except as an axiom. The monetary policy can and should attempt to manage fluctuations in employment. Rather simply set a monetary environment commensurate with the long run potential to increase production -- quote. These individuals seek policies that attempt to manage the fluctuations in employment over the short right. Now the active pursuit unemployment objectives as has been and continues to be problematic for the Fed. Most economists are dubious of the ability of monetary policy too predictably and
precisely control employment in the short run. And there's a strong consensus. In the long run monetary policy cannot determine employment. As the F -- -- noted in its own statement on longer run goals adopted in 2012. I quote the maximum level of employment is largely determined by non monetary factors that affect the structure. In dynamics of the labor market. In my view focusing on short on control of employment weakens the credibility and effectiveness. Of the Fed in achieving its price stability
objective. We learned this lesson most dramatically during the 1970s. When despite extensive efforts to reduce unemployment the set -- essentially failed. The nation experienced a prolonged period of high unemployment and high inflation. The economy paid a price in the form of a deep recession. As the Fed sought to restore the credibility of its commitment commitment to price stability. So -- a stab us in the long term goals and objectives for any organization. And particularly one that serves the public.
It is essential that the goals the achievable. Signing on achievable goals organizations. Is a recipe for their failure. But the Fed could mean a loss of public confidence. I fear that the public has come to expect too much from the central bank and too much from monetary policy in particular. I believe we need to heed the words of another Nobel Prize winner Milton Friedman. 1967. And his presidential address the American Economic Association he said and I quote. We are in danger reciting the monetary
policy a larger role that can perform. In danger of asking it to accomplish tasks. Cannot achieve. And as a result in danger preventing it from making the contributions. That it is capable of making -- -- In 1970s we saw the wisdom of treatments earlier admonitions. I think over the past forty years with the exception perhaps the Paul -- error we failed to heed this warning. We've assigned an ever expanding role for monetary policy. We expect our Central Bank to solve all -- economic -- which is ill suited
to address. We need to better align the expectations of monetary policy for what is actually capable of achieving. The so called dual mandate -- contribute to this expansionary view of the powers of monetary policy. Even though in 2012 a statement of objectives acknowledged. That it is inappropriate to set a fixed goal for employment. And that maximum employment is influenced by many other factors. At -- c.'s recent policy statements have increasingly given the impression that it wants to proceed. It wants
to achieve specific employment goal as quickly as possible. I believe that the aggressive pursuit of broad and expand its expansive objectives is really quite risky. Make it -- very. Undesirable repercussions down the road. Including undermined the public's confidence in the institution. Its legitimacy. And ultimately its independence. To put this in a different terms. Assigning multiple objective for Central Bank opens the door for highly discretionary policies. Which can be justified by shifting the focus
or rationale for action from goal to goal pillar to post. I've concluded that it be appropriate to redefine the Fed's monetary goals to focus solely or at least primarily on price stability. A basis on two observations. First monetary policy has very limited ability and -- real variables such as employment. And and regime with Fiat currency only the Central Bank can ensure price stability. Indeed price stability is the 1 goal that the Central Bank can't achieve over the long run. But even with a narrower
mandate to focus on price stability the institution must be well designed if it's to be effective. And successful. To meet that even this narrow mandate the Central Bank must have a fair amount of independence from the political process. So that he can set policy for the long run. Without pressure to print money as a substitute for tough fiscal choices. I believe good governance requires. A healthy degree of separation. Between those responsible for taxes and expenditures. And those responsible. For
printing money. The original design of the -- governance recognize the importance of such independence. Consider its decentralized. Public private structure. With governors appointed by the US president and confirmed by the senate. And fed presidents chosen by their boards of directors. This design helps ensure a diversity of views. And they more decentralized governance structure. I think reduces the potential for abuse is. And captured by special interest or political agendas. Also reinforces the
independence of monetary policy making and that leads to better economic outcomes. Such independence and democracy also necessitates the Central Bank remain accountable. Its activities need to be constrained in a -- that limits its discretionary authorities. Is already argued a narrow mandate is an important limiting factor on this expand on an expansionist view of the role and scope for monetary policy. What other sorts of constraints are appropriate. In the activities of central banks. The monetary policy
in this apology it policy should have clear boundaries. Independence is what congress can and should grant the -- But in exchange for such independence the Central Bank should be constrained. From conducting this policy. Is I've already mentioned the Fed is injured in the realm that's good policy by its purchase programs of assets that target various industries are individual firms. One way to circumscribed such -- -- fiscal actions is to limit the types of assets that the -- can hold on its balance sheet.
Now on his system open market -- the Fed has allowed to hold only US government securities. And securities that are direct obligations. Or fully guaranteed by agencies. -- United States. These restrictions still out -- at the purchase large volumes of mortgage backed securities in its effort to boost the housing sector. My preference would be to limit the Fed's purchases to -- securities in return the Fed's balance sheet to an all treasuries portfolio. This would limit the ability of -- to engage in credit
policies that target specific industries. As already noted such programs to allocate credit rightfully belong in the realm of the fiscal parties not the Central Bank. A third way to constrain the central bank's actions as direct the monetary authority to conduct policy in a systematic rule like manner. It's often difficult for policymakers to choose a systematic rule like approach. As it would -- their hands and thus limit their discretionary authority. Yet resource throughout the years has discussed the
benefits of rule like behavior for and and they discovered the rules are -- transparent and therefore allow for simpler and more effective communications policy. Moreover a large body of research emphasizes the important role expectations. Play in determining economic outcomes. Policy is set systematically the public in financial market participants conform better expectations about policy. Policy is just no longer a source of instability. Or uncertain. Now while choosing -- approved appropriate rule is
important. Research shows that why in a wide variety of models. There are simple robust monetary rules that can produce outcomes very close those delivered by each models optimal policy. Systematic policy can also help preserve a central bank's independence. When the public has a better understanding of policy makers' intentions. It's able to hold the Central Bank more accountable for its actions. And the rule like behavior helps to keep policy focused. On the central banks more narrow objectives. Limiting
discretionary actions that may wander towards other agendas. And other goals. Congress is not appropriate by determined this form of such a however congress could direct the monetary authority to communicate the broad guidelines they will -- to conduct policy. One way this might work is to require the -- to publicly described. How it will systematically conduct policy in normal times. This might be incorporated the semiannual monetary policy report submitted to congress. This would hold them accountable.
The FOMC chooses to deviate from the got guidelines which they may do sometimes. It must then explain why. And how it intends to return. To those prescribed guidelines. My -- is that the recent difficulty the Fed has faced in trying to offer clear and transparent guidance on its current and future policy. Stems from the fact that policymakers still desire to maintain discretion. In setting monetary policy. That's not to beat down by rule like behavior. Effective forward guidance however requires commitment.
Commitment to behave in a particular way in the future. But discretion is the antithesis of commitment. And undermines the effectiveness of forward guidance. So given this tension. Between discretion and commitment. You should be surprised that the -- struggled -- -- communication. So what's the answer. While I C three and I've been talking. Simplify the goals. Constrain the tools. And make decisions more systematically. All three steps can lead to clear communications. A better understanding on the part of
the public of what monetary policy is doing. Creating a stronger monetary policy framework will ultimately produce better economic outcomes. Before concluding I'd like say -- few words about the role the Central Bank plays in promoting financial stability. Since the financial crisis there has been an expansion of the Fed's responsibilities for controlling macro credential and systemic risk. So -- didn't call for expansion of the monetary policy mandate to include explicit goal of financial stability. I
think this could be at stake. The Fed plays an important role and should as the lender of last resort. Offering liquidity to solve it firms. In times of extreme financial stress to forestall contagion and mitigate systemic risk. This liquidity is intended to help ensure that solvent firms. Facing temporary liquidity problems. Remain solvent. That there is sufficient liquidity in the banking system to meet the demand for currency. In this sets liquidity lending is simply providing an elastic currency. That's
the role of lender of last resort is not. To prop up insolvent institutions. Or sovereigns for that matter. However in some cases during the crisis the Fed played a role in the resolution particularly particular insolvent firms. There were deemed systemically important. Subsequently the Dodd-Frank act has limited some of the -- actions the Fed can take -- individual forums under section thirteen three. Nonetheless -- taking these actions the Fed has created expectations perhaps only realistic ones but what
the Fed can't. And should do to combat financial stability. Justice -- for monetary policy it's important to be clear about the Fed's responsibility for promoting financial stability. I think it's unrealistic to expect the Central Bank to alleviate all systemic risk opening -- markets. Spain the Fed's regulatory responsibilities. To broadly. Increases the chances Adobe short run conflicts between its monetary policy goals in its supervisory and regulatory goals. This should be avoided. As once again it
undermines the credibility institution and allows for fast discretion. Similarly it. The Central Bank should set limits. And communicate those limits and guidelines for its lending policies that he can and can't crack in that it can -- it can credibly commit to fall. The set of institutions having regular access to fed credit facilities is expanded to talk. You'll create moral hazard distort market mechanisms for allocating credit. This can end up undermining the very financial stability it's supposed to be
promoting. Emergencies can and do arise as we all know. So the fairness asked by the fiscal authorities intervened by allocating credit to particular firms -- sectors of the economy. In this the treasury should take these assets off the Fed's balance sheet and exchange them for treasury securities. In 2009. Almost. Almost four years ago I advocated that we established a new court between the treasury and the Federal Reserve that protects the -- in just such a way. It would help ensure that when credit
policies. Put taxpayer funds at risk in the name emergency. They other responsibility of the fiscal authorities not to fit. This new accord also returned control the Fed's balance sheet back to the fifth so that it can could can continue to conduct independent. -- -- Many observers think the financial instability is endemic to the financial industry and the airport must be control regulation and oversight. Number of financial and this instability can also be a consequence. Of government and the policies.
Even though sometimes those that are intended to reduce instability. I give it 3 ways in which Central Bank policies can increase the risk of financial instability. First. I rescuing firms are creating expectations creditors will be rescued. Policy makers either implicitly or explicitly create moral hazard and excessive risk taking by financial firms. Pointed out this moral hazard to exist it doesn't matter if it's the tax Payer. While the private sector that provides the funding for such rescues. What
matters is that creditors are protected. At least in part. Second by running credit policies such as buying huge volumes of mortgage backed securities or other assets that distort market signals or the allocation of capital. Policy makers consultancy to financial instability. Because the distortions they create. In time must be corrected. Such adjustments to be painful and actually quite disruptive. Third. By taking highly discretionary approach to monetary policy policy makers increased the risk of
financial instability. I'm making monetary policy uncertain. Such uncertainty can -- markets to make unwise investment decisions. Witness the complaints of many of those who took positions expecting the Fed to follow through with the -- decision in September. Of this year but did not. The Fed and other policy makers I think need to think more. About the way their policies might contribute to financial instability. I believe it is important that the bad take steps to conduct its own policies. And help other
regulators to reduce the contribution of such policies to financial instability. More limited role for the Central Bank I've described. Here is a contribution to such an effort. So in summary. Financial crisis in the aftermath have been challenging time for global economies and our institutions. Extraordinary actions taken by the by the -- to combat the crisis in the ensuing recession. Have expanded the roles assigned to monetary policy. My view is the public has come to expect much from its back. To remedy
this situation I believe would be appropriate to set for limits -- at. First. In the -- the Fed's monetary policy goals to a narrow mandate. In which price stability is the sole or at least the primary. Objective. Second. Limit the types of assets that the Fed can hold on its balance sheet to treasury securities. Europe and at the press -- discretion monetary policy by requiring a more systematic approach to conduct policy. And for -- to limit the boundaries. Of its lender of last resort. Powers ensure that
they are conducted it used in the systematic. And predictable fashion. These steps would yield a more limited Central Bank. But in doing so I think they would help preserve the central bank's independence. Thereby improving the effectiveness of monetary policy. The same time I think it would make it easier for the public to hold of that accountable. -- policy decisions and outcomes. I believe these changes to the institution could strengthen the Fed. But the next 100 years thank you very much. -- Thanks
very much for that thoughtful important talk. We get time but ten minutes to take a few questions so. If you wanna raise your hand and identify yourself and keep your questions short. There's a microphone coming grounds I don't see. Here. Is raise your hands high so I can see it for the right here. Officer of the monetary provisions of the constitution were largely authored by a founder Roger Sherman. Who -- 1752. Wrote a treatise entitled. A caveat against injustice on the evils of both fluctuating media
of exchange describing how a fluctuating or elastic. Monetary unit was used in this ebbing and flowing -- actually transfer steel wealth. How would. You differentiate between that term a fluctuating. Medium of exchange and an elastic medium of exchange. Well LSB Hussein was primarily yet and the motivation was prior to 1913. Interest rates and other forms of credit were highly seasonal. It X they were fluctuating with the seasons. And it had to do with geographic dispersion of where cash wise. And so. The
idea at the time in 1913 was that the Fed would. Would be able to smooth out those fluctuations in interest rates to prevent the very predictable seasonal fluctuations. By allowing notes in particular to be more readily available to meet the fluctuating demands it was not. To undo the effects of the gold -- that was in place he was to smooth out the job. The -- primarily the seasonal fluctuations but also recognize that in -- periods of panic. The private clearing houses which dominated. The way. Banks.
Cleared notes and got it got. Access to notes. Covered not all banks in the country and so while the close clearing houses were pretty -- pretty well in some areas it didn't work universally well. And so -- in from that point of view the motivation was to make the -- what amounted to a clearing house. To smooth the fluctuations in the supply notes. It -- the gold standard did not prevent. The price level from fluctuating clearly -- because the price of gold would fluctuate but. But. But that was the thought
of what the elastic currency was supposed to do. Sorry I can't see you must like. Right. Martin how auctions in the -- I -- You'll lose. That the Fed. Be passed through them. Have monetary stability. Or price stability is one of its major objectives. But we've not got a system which the Fed has 2% inflation which isn't stability its slow erosion. I am. Do you see that those. Damaging do you see any real dangers in having a zero talking all of them -- 2% talkies. In other words -- of the dangers of mild
deflation. Yet minus no point 5% I've been on the. So. I get from from from some of my colleague is I'm not nearly as afraid of zero inflation a mild deflation are -- after all. Let Milton Friedman's classic papers on the optimum quality money suggested that mild deflation was actually. Desirable. And indeed that proposition at least in theory is held up in a wide class of models. So it's not obvious that mild deflation is such a bet is such a bad thing for me. I think the value -- inflation target is a
form of a commitment. And it really doesn't matter quite as much less than number was one and a half percent or two and a half percent or 2%. It's it's that it's the signaling of a commitment of the institution to deliver something in particular. And and and and commit today in Seoul. I was less concerned about what the actual number was -- -- would actually it probably made it lower. But but. -- I didn't. What was more important was the signal of a commitment. That this is what we're gonna provide. And
different people had different rationales for why they think you know it ought to be positive -- zero. I saw Paul Volcker and train station last night coming in. I asking will not -- what's wrong with zero inflation he laughed and he agrees. But there are technical issues for the bad in terms of operating. We're zero as we've seen become somewhat problematic for for certain types of things. Mostly becomes problematic because in their desire to sort of provide -- respond the economy is sort of limits their
movements in the downside. Actually think monetary policy needs to respond to the economy. When he economy's weak. In monetary policy needs to be at a lower interest rate because that's the way the economy wants to respond -- that you're correcting the economy. It's you just don't want monetary policy you're trying to create a stable price level or 2% inflation rate in need to move. Somewhat with the economy and if you already at zero interest rates and or 1% interest you don't have much room for that --
that's -- one argument people use. And maybe a bit overblown from my taste but. Again I think the value of the target is the commitment. More than the number. On Richard cameras my name. And I'm curious about. How much. Ben Bernanke runs to show or. You know is is this is the government of the -- kind of democracy and occasionally he gets out voted and it doesn't go his way or. Can I learn everything is going on in the -- despite by listening to what Bernanke says on TV. You know I I think. Chairman
Bernanke is an incredibly capable and collegial. Individual. I'm not running for 35 years something like that. Very bright and capable. But the chairman is the chairman like any ill like any border directors or anything else. Everybody has a voting in but the chairman thought oftentimes counts more than more than the others and that's perhaps as it should be. But having said that. If that does that -- just probably not true democracy. But on the other hand. It is say -- Is very open. Collegial debate within
the community. You know under and under some regimes you you can't imagine me saying what I said today wish if it wasn't if it wasn't -- So I think it is a very healthy environment you can learn a lot about what the chairman things but that doesn't mean you learn everything about what the committee's thinking about by just listening to the chairman. I think that's the bad you. Presidents and other governors going out and speaking about the things that are on their mind. The things that concern them their
thoughts about policy. That's about to me is about transparency in the more transparency we can make about what other debates if you will within side. Policy making authorities what are those debates about is about communicating to the public about where we are. And what we're thinking about what the challenges are what the difficulties are. It doesn't provide all the answers that's a form of informing the public about the nature of the debates and I actually believe some people don't like the act. I
actually believe. That that's helpful because. It's helpful because. It tells the public in help. These people really debating some of the same issues that I'm worried about regards what the ultimate answer is. This variety of views is being carried out within the institution. That's healthy it's it should be comforting to the public. That you hear those different points of views and you hear that debate in public speeches regardless of how. At the end of the day a -- goes or decision goes you know hold a
different voices have been heard. That those debates are being had. That should be. From my -- both good for transparency. But good for building more confidence in the institution. That's the way I think about it. One more question are. And Jim Allen was CFA institute with regard to your proposal about. The treasury sort of replacing. Non treasuries with treasuries. There's a certain amount of -- discretion that we go into how of those instruments are how to swap is valued. Eyes there's some some mechanism
some sort of rule that you might put in place with regard to how those are valued. Well that that could be at that might depend a lot on the circumstances but it at independent with -- yes it themselves are. Which although the Fed acquired a bunch of assets and put a value on when they. When they acquired him. And and I -- reason why you just wouldn't use that prices the starting point for saying you know how would you swap them out for treasuries. But I think that that's less important at the end of the
day. I don't think you would want for example to force. A capital gain or loss on the Fed by how you did that swap. I think he probably just take it whatever the price they paid for might be the simplest way to do it in a boy boy -- that discretion. But them but the more important message here is is that. My idea is that yes central banks that aren't unique position in the financial markets to do things do them quickly. With some flexibility. But I don't think they ought to do them on their own authority so
my view is is that if you're going to ask the bad. To help a financial situation that the treasury and the political process wants to effectuate. We can't carry out that exercise for on behalf. Of the administration the treasury of the congress we didn't execute it we are their fiscal agent after all. But it's their decision to ask us to do it yet and then they relieve us. Of the responsibility for both oversight. And the fiscal aspects of that decision by giving us treasury bills that -- treasury bills and
bonds in exchange. Then we're back to be able to conduct ordinary monetary policy in independent way without. Over burden of managing. Perhaps a bunch of assets that. We are not particularly equipped to or should be engaged in because they were assets -- for fiscal policy reasons not. Monitors sort it restores control