As FT Alphaville noted before, the role of the FOMC is about more than just conducting monetary operations. It’s also about moulding investor opinion and expectation.
So, when traditional monetary tools of the Federal Reserve dry up, it’s understandable that the Fed’s
propaganda mind manipulation tactics step up a notch. The dependence on ‘Jedi economics’ simply becomes greater.
Narayana Kocherlakota, president of the Federal Reserve Bank of Minneapolis — and recent dissenter — has noted as much in a speech to the National Association of State Treasurers in North Dakota.
As he discussed, citing a historical quote about North Dakota’s propensity for flooding:
“Men seem to live in the future rather than in the present: not that they fail to work while it is called for to-day, but they see the country not merely as it is, but as it will be, twenty, fifty, a hundred years hence.”
As I said, the Committee meets eight times per year. Its deliberations concern the appropriate readjustment of monetary policy to the new information received since the last meeting. But, as was true of the early settlers of our great continent, the Committee has to keep in mind its medium-term and indeed long-term goals when making those readjustments. And it must also keep in mind the public’s understanding of those goals. This perspective – that good policy responds to the current conditions so as to achieve certain well-communicated future goals – will be a key theme for the remainder of my remarks.
As I said, though, it is not enough to have an objective – the Federal Reserve must also communicate that objective clearly. That communication serves to anchor medium- and long-term inflationary expectations. Put another way, without clear communication of objectives, the public can only guess at the intentions of the FOMC. Inflationary expectations and inflation itself will inevitably end up fluctuating – and possibly by a lot. As I’ll discuss later, it is possible to undo these shifts in expectations, but only at significant economic cost.
The Federal Reserve communicates its objective for inflation in a number of ways. For example, at quarterly intervals, FOMC meeting participants publicly reveal their forecasts for inflation five years hence, assuming that monetary policy is optimal. Those forecasts usually range between 1.5 percent and 2 percent per year. They are often collectively referred to by saying that the Federal Reserve views inflation as being “mandate-consistent” if it is running at “2 percent or a bit under.” But the Fed has also communicated its intentions more directly and more broadly. Last December, for example, on the television program “60 Minutes,” Chairman Bernanke explained the dangers of letting inflation fall too low relative to this 2-percent-or-a-bit-under range. In the same interview, he also emphasized that the FOMC is unwilling to allow inflation to rise above this range…
As I’ll describe in more detail later in my speech, the economy was hit in the past three and a half years by shocks that had the potential to drive inflation significantly downward. I believe that the FOMC’s clear communication of its inflation objective has helped the FOMC keep inflation from falling too low in the face of those shocks.
At the same time, clear communication of its objective has also allowed the FOMC to follow highly accommodative monetary policies – like keeping interest rates near zero for nearly three years – without triggering large upward movements in inflationary expectations.
I’ve been emphasizing the importance of communication – and communication matters greatly. But, ultimately, the public’s beliefs about the FOMC’s inflation objective will also depend on inflationary outcomes. If annual inflation averages less than 1.5 percent for more than three or four years, onlookers will begin to suspect that the FOMC’s true objective for inflation is lower than its declared “two percent or a bit under.” Correspondingly, if inflation is persistently higher than 2 percent, then the public will begin to believe that the FOMC’s true objective for inflation is higher than 2 percent. In either case, inflation expectations could become unmoored, and the FOMC could lose control of inflation itself. Communication can only be effective if the FOMC also retains credibility.
Given the above, and appreciating Kocherlakota’s prominent role on the FOMC Jedi council (strong in the ways of the FOMC, is Kocherlakota) — his, and two other members’, recent dissents suggest a definitive rupture is hitting the body.
The question is, which side is Obi-Ben-Kenobi really on? And who else will be tempted into joining Kocherlakota on the inflation side?
(Or could the divide just be part of the Jedi mindtrick? – Ed)