Minneapolis Fed President Kocherlakota pushes for greater clarity in Fed policy

The informal tribe of Wall Street analysts, economists and financial journalists known as “Fed watchers” don’t expect much concrete action from the two-day meeting of the Federal Open Market Committee. But they will be closely listening to what Fed Chairman Ben Bernanke says at a press conference this afternoon explaining the actions and thinking of the current 10-member policy-setting body.

And Minneapolis Fed President Narayana Kocherlakota, an FOMC member, thinks the press conference is as important as any policy moves the Fed might make on short-term interest rates or buying back government securities.

Narayana Kocherlakota
Narayana Kocherlakota

 As the Fed tries to manage its twin mandates — to support maximum employment and price stability — he argues that the formerly secretive and opaque central bank needs to do a much better job of explaining its decision-making to the public.

At a recent gathering in  Minneapolis, Kocherlakota responded  to an audience member’s observation about rising public concerns over the soundness of the dollar,  saying the question  ”gets at the heart of the communications and education issue” the Fed faces.

At the core are the unprecedented moves made following the market meltdown in 2008 when the Fed added $2 trillion in assets to its balance sheet, rekindling fears of a return to 1970’s rampant inflation. If the financial markets and the public don’t have confidence in the Fed’s commitment to meeting its ‘dual mandate’ or believe the policy moves are ineffective, inflationary expectations can become self-fulfilling, he said.

Kocherlakota said Bernanke has the opportunity to be more transparent. “Instead of trying to communicate what we’re doing in this cramped one-page statement, now [Bernanke] is able to provide the color and articulate what’s going on” in Fed policy deliberations, Kocherlakota told  that Minneapolis gathering.

The third Bernanke press conference this year, ushered in by the Fed chairman following last April’s FOMC meeting, is taking place as financial markets remain skittish, the euro teeters on the precipice of a Greek default, the “Gang of Six” in Congress struggles to hammer out a balanced-budget solution, and the economy struggles to find solid footing. 

As the central bank tries to nudge the economy forward after the Great Recession, it also must deal with rare public dissent about policy among the members of the FOMC. As one of those dissenting voices, Kocherlakota calls the press conferences a “fantastic idea” but thinks the Fed needs to do a much better job making its policy intentions clear.

Speaking to the Harvard Club of Minnesota, Kocherlakota presented what he called a “mandate dashboard” laying out current unemployment and inflation rates as well as Fed consensus on the future direction of both those measures.

“Just as a driver should adjust acceleration according to information provided by his dashboard, the FOMC should vary the level of monetary accommodation in response to changes in the mandate dashboard,” Kocherlakota explained. “For example, the November 2010 dashboard shows that the FOMC expected the unemployment rate to fall over time — slowly — and the inflation rate to rise — slightly. As that happens, the FOMC should respond by slowly lowering its immense level of monetary accommodation.”

“I think it’s very important for us to make clear what the tradeoffs are that we’re being guided by when we make policy,” he said. “If we become clear about that framework, it may turn out that the right policy is having inflation run above 2 percent for some period of time.”

While he’s discussed the mandate dashboard with FOMC colleagues, Kocherlakota doesn’t expect to see Bernanke referring to a mandate dashboard at press conferences anytime soon.

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After a 24-year career as a university professor, including chairman of the economics department at the University of Minnesota, Kocherlakota’s own communication tools are well-honed. He also is not alone in recognizing the communication challenges the Fed faces. In fact, Bernanke began the press conferences, breaking with a 98-year Fed tradition of saying little or nothing about policy moves.

Charles Evans, president of the Federal Reserve Bank of Chicago, recently proposed keeping short-term rates at zero until either the unemployment rate falls below 7 percent or the outlook for medium-term inflation goes above 3 percent. While Kocherlakota does not necessarily subscribe to those limits, he applauds Evans for laying out a clear framework for explaining Fed policy moves.

With core inflation (prices excluding fuel and food) running below 2 percent, deflation, or falling prices, has been a bigger Fed concern recently, Kocherlakota said. But critics still worry about future inflation, and here is where the Fed has done a poor job of communication, he believes.

When Congress empowered the Fed to buy toxic bank assets in 2008, it also granted the ability to pay interest on bank reserves it holds, a new authority the Fed had lacked previously. Kocherlakota said the Fed can use this new tool to control the expansion of money, and thus control inflation. But that new power has been poorly explained to the public, he said.

“It’s easier for people to listen to criticisms than it is to listen to explanations of why those criticisms may not be valid,” he argued. Critics will say the Fed “print(s) a lot of money. It’s going to create inflation. You’ve got that once sentence on the record. I give my explanation of why that’s not true and somewhere in the middle of that you might fall asleep.”

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