Janet Yellen, the vice chairman of the Federal Reserve, is the latest in a string of Fed bigwigs to get behind an idea of using explicit inflation and unemployment targets to inform the market about the Fed’s future plans – forward guidance, in Fed-speak. During a speech to the Haas School of Business at the University of California, Berkley, Yellen endorsed the idea of moving beyond calendar-date approximations as the means of conveying information on the Fed’s future moves. Now, she stopped short of actually naming any sort of numbers, but this seems like a good direction for the Fed to move. Ms. Yellen knows what she’s talking about too; in 2010, Fed chairman Ben Bernanke appointed her the chair of a new FOMC communications subcommittee. Not to mention that if Bernanke decides not to accept a third term at the head of the Fed, Ms. Yellen is widely seen as first in line as his replacement.
This is ground that’s already been trod by Charles Evans at the Chicago Fed and Narayana Kocherlakota at the Minneapolis Fed. Essentially, the idea is to set up explicit thresholds for inflation and unemployment measures (the two mandates for the Fed) to help set expectations about the future of monetary policy if there should be a disconnect between the two. For example, if inflation is at or near the presumptive 2% to 2.5% target, yet unemployment above its normal levels, markets need to know that the Fed won’t clamp down on its easy money policy just because inflation is “too high.” Doing so seems like a win-win strategy. If inflation ticks up and unemployment remains higher than desired, markets can take solace in the fact that the Fed won’t “take away the punchbowl.” Conversely, if inflation is within range and unemployment settles closer and closer to its long-run average, markets will have plenty of warning that the era of easy money is coming close to an end.
For now, markets didn’t seem to see the win-win nature of such comments. In fact, some blogs like Free Exchange at The Economist and Tim Duy’s Fed Watch were encouraged, but somewhat pessimistic (Duy maybe a little more so). Duy was left wondering why the dovish tone of Yellen’s speech wasn’t “good for a 1% rally.” Duy’s main explanation to me seemed to be that if the Fed is already “all-in” with an open-ended asset purchase program, then a dovish speech from a Fedster isn’t going to yield the market reaction it would have in the past and changes in communication strategy may not either. I’ve mentioned these types of “guideposts” before, in my post about Richmond Fed prez Jeffrey Lacker. Lacker has dissented from the FOMC opinion at every meeting this year, and one of his issues has been with the forward guidance. He “disagreed with the description of the time period over which a highly accommodative stance of monetary policy will remain appropriate.” There’s that idea of “time periods” again.
The latest FOMC minutes also revealed a more detailed discussion of a communication strategy. Matthew Yglesias pulled the relevant section of the minutes on his Slate blog. Like Matthew, I do think that the FOMC will ultimately come up with some version of either explicit thresholds, a la Evans, or a qualitative description of the variables influencing monetary policy. These guys and gals are rigorous academics and will, as Matthew points out, want to have all kinks out the discussion before going public.
I remain a strong believer that it’s good to get inflation expectations higher. And a Fed communications strategy that lets the public know that it will tolerate a short-term bout of higher inflation while the unemployment rate works its way down is probably a good thing. With so many at the Fed talking about specific language on their targets, I hope that it will be a mantle “officially” taken up by Ben and company in the very near future.