I haven’t seen anyone comment on this odd exchange at the Bernanke press conference:
STEVE BECKNER: Steve Beckner of MNI, Mr. Chairman. There have been concerns, raised questions raised by people like Columbia Professor Michael Woodford and others about the credibility of your forward guidance on the path, future path of the federal funds rate. The idea being that to the extent it’s conditional, it’s not really convincing and doesn’t provide the kind of confidence that you referred to. Now on this latest statement you’ve removed some of that conditionality. I am particularly struck by the statement that the committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens. I assume that was done to make your forward guidance more credible and yet the question remains whether, you know, as the economy picks up steam, whether the FOMC will really follow through and keep rates low or whether you will do as the Fed has always done and begin to raise the funds rate.
CHAIRMAN BERNANKE: Well, that’s an important question. Michael Woodford who by the way is my former colleague and co-author and friend so I know him quite well and I know his works quite well. I think, actually, the thrust of his research is that forward guidance communication about future policy is in fact the most powerful tool that central banks have when the interest rate is close to zero. And he advocates policies like nominal GDP targeting for example that would essentially require a credibility lasting many years. The implication being that the Fed would target the nominal level of GDP. And promise to do that for many years in the future even if inflation, you know, rose as part of that policy. So his own perspective is that credibility is the key tool that central banks have in order to get traction at the zero lower bound. Whether we have the credibility to persuade markets that we’ll follow through is an empirical question. And the evidence which I also again discussed in my remarks recently is that when we’ve announced extended guidance that financial markets have responded to that, that private sector forecasters have changed their estimates of what unemployment and inflation will be when the Fed begins to remove accommodation. So the empirical evidence is that our announcements do have considerable credibility. And I think there’s good reason for that, which is that we have talked a lot both publicly and privately about the rationale for maintaining rates low even as the economy strengthens, and I think the basic ideas are broadly espoused within the Committee. And so there is a consensus that even as the personnel change and so going forward, that this is the appropriate approach, and that by following through, we will have created a reserve of credibility that we can use in any subsequent episodes that occur.
1. The reporter asks about Woodford’s claim that level targeting can add credibility to Fed policy, but that the markets have to believe the Fed will actually carry through with the promises. Note that the Fed didn’t adopt the sort of explicit level targeting that Woodford wants, so you might have expected Bernanke to defend the Fed’s decision to refrain from doing so. (Level targeting would have required a higher short run inflation target, and hence would have been very controversial.) But Bernanke’s answer basically defends Woodford’s argument, as he went out of his way to insist that the Fed’s promises (to keep money accommodative well into a recovery) will definitely have credibility in the markets. He’s on Woodford’s side.
2. Even more surprisingly, much of the answer is devoted to NGDP targeting, even though the reporter never even mentioned NGDP, indeed it wasn’t really even alluded to. And the entire answer is 100% pro-Woodford. There’s not even a hint of disagreement with Woodford in the answer. Why doesn’t Bernanke say the Fed avoided NGDP targeting because it’s a bad idea?
Perhaps because he’s privately hoping that the markets interpret the Fed’s recent action as NGDPLT in disguise?
Or perhaps that’s just the deluded fantasy of a blogger whose ego has been inflated to Hindenburg zeppelin proportions by some overly generous press coverage.
In late 2010 the Fed was concerned that inflation had fallen below 2%, and thus they adopted the QE2 program. When the Fed announced that the intention was to raise inflation, there was a firestorm of criticism from the public. I did about 20 posts arguing that the Fed shouldn’t announce the goal of raising the public’s cost of living, but rather they should say the goal is to raise peoples’ incomes, with the ultimate goal being more real output. Not to deceive the public, but because that’s what they were actually trying to do. The Fed has forecast that inflation will gradually rise to 2% over the next few years, but note that Bernanke no longer points to higher inflation as a policy goal:
STEVE LIESMAN: Mr. Chairman, I want to talk about that same line in the statement. Does that mean that your tolerance for inflation will be higher in the coming years in the middle of the recovery? And if not, what good is that language there if it doesn’t tell people that the reaction function relative to inflation has changed? Secondly, stock prices are up today, so are oil prices and gold. Why aren’t those part of the same reaction to the Fed’s acts today?
CHAIRMAN BERNANKE: Well our policy approach doesn’t involve intentionally trying to raise inflation. That’s not the objective. The idea is to make sure we provide enough support so the economy will grow fast enough to bring unemployment down over time.
That’s close enough for me, although I prefer he use the term ‘NGDP’ rather than “the economy.”