Thursday, November 15, 2007

Article in Question: Fed to Share More of Its Thinking in Its Reports

The article, “Fed to Share More of Its Thinking in Its Reports,” is published in the New York Times of November 15, 2007.

Statement from the article: “Mr. Greenspan staunchly opposed all proposals for “inflation targeting,” contending that explicit public commitments would limit the Fed’s ability to respond nimbly to unexpected developments.”…..

Alan S. Blinder, an economics professor at Princeton and a former vice chairman of the Federal Reserve, said the Fed should have moved more decisively. “If you are a big believer in transparency, which I am, it’s incremental,” Mr. Blinder said. “If I had my druthers, the Fed would be giving out a forecast eight times a year.”

My opinion: Yes, the Fed should be more open about policy decisions; this builds credibility. I disagree with the author’s remarks regarding Alan Greenspan and notice his obvious confusion regarding an inflation target.

An inflation target may be a good policy choice; it is a tight band where inflation must remain. If a central bank (the Federal Reserve Bank) announces a specific policy, and the public believes the announcement, then the policy is much more effective. Thus, an inflation target creates a larger degree of "believability."

Let’s say that the economy is in growing too quickly, with inflation creeping up. Further, assume that the central bank announces a policy to reduce inflation. If the public believes the Fed’s announcement (more credible), then they will assume that the central bank will “fix” the economic problem, and output will be quite stable. Inflation will fall, and the economy will not incur too much heartache, such as rising unemployment, along the way. An inflation target adds (perhaps) credibility to the central bank because the policy is transparent, but it is only one way to gain credibility. Another way to gain credibility is by a Chair having a history of good policy decisions. This is why Alan Greenspan is such a venerable Chair. Over a decade of low and stable inflation is attributed to Alan Greenspan.

Edmund L. Andrews, author of the article, took Prof. Blinder’s comments out of context. Prof. Blinder comments that he advocates a higher frequency of information releases by the Fed – specifically, that the Fed present its forecasts eight times a year. Why would he advocate this? If the Fed reveals more information, then it develops a stronger relationship with the public that stimulates its credibility. The public may interpret the Fed’s actions as a signal of openness and good will – again, a more credible authority. Prof. Blinder does not advocate an inflation target per se. He simply advocates more transparency.

The way that I read this article can be summarized as follows. Edmund L. Andrews does not understand why a monetary authority would choose an inflation target; there are alternate policy options that offer a higher degree of credibility to the Fed.

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