The Increasingly Transparent Federal Reserve

The Federal Reserve has become significantly more transparent in the past few years.  Amid appeals from Congress and the public to "audit the Fed," they posted to their homepage, that they get audited by the Government Accountability Office.  Chairman Bernanke has even recently started giving press conferences and this week they announced that they would release their Federal Funds Rate forecasts.  They announced it from the minutes from the December F.O.M.C. meeting.  This has been a pet project of Chairman Bernanke for some time, he gave a speech in 2010 on the subject.  To many, this might come as an obvious positive step, but I'm left scratching my head a bit.  I'm thinking... how is this going to help and how might it harm the pursuit of monetary policy?



(photo: MeDill News Service)



There are two issues in monetary policy that relate to this, and they are (as most things in monetary policy) opposing relationship to one another.  The first issue is central bank credibility.  It could be said that the Federal Reserve's reputation as a Central Bank has suffered in the past few years (rightly or wrongly) in the eyes of the general public.  In this sense their credibility has gone down.  Most monetary economists, not the Austrian school (of course), give high marks for the job that they have done.



The second issue is information asymmetry.  Not many people write about it (perhaps because it is elementary Keynesian economics, but perhaps not), but nominal price changes waxing over real price changes is a product of not much more than an enormous information asymmetry problem with regard to fiduciary media (money).  Robert Barro was (maybe) the first to write about it in his article "Rational Expectations and the Role of Monetary Policy." (gated)  I'm writing about the issue as a potential moral dilemma in "The Morality of Monetary Policy" (forthcoming).  The root of this idea is a purely Keynesian one, "Whilst workers will usually resist a reduction of money-wages, it is not their practice to withdraw their labor whenever there is a rise in the price of wage-goods.  It is sometimes said that it would be illogical for labor to resist a reduction of money-wages, but not to resist a reduction of real wages." (Keynes, The General Theory of Employment, Interest and Money, 9) This demonstrates what has come to be known as wage rigidity, an example of sticky prices.

So, if information asymmetry is essential for nominal changes in prices to affect positive changes in output, then why is Bernanke's Fed reducing it?  I think that is because of rational expectations.  Rational expectations involve what the public thinks the future value of money will be.  Typically, expectations are formed from the average of the past few quarters price movements (inflationary or deflationary).  This is why monetary economists are interested in trend inflation, because we think that we are measuring expectations.  There can be deviations from this when the consumer has information that runs strongly counter to this.  Also, inflation can deviate from this when it begins to escalate take on a momentum of its own.

Keeping expectations within trend inflation is easy for a central bank with a good reputation, but not easy for one that does not.  Bernanke's moves towards transparency likely show that he is interested in promoting the Central Bank as credible, and promoting the effects of shrinking the money supply as soon as he can or sooner.

This is likely a good move, as long as he understands that when or if the Fed needs to expand the money supply again... they likely will need to increase information asymmetry rather than decrease it.  So if Bernanke is using this as a tool to promote Fed actions to curb inflation when inflation becomes more of a problem, I'm all for it.  If he's planning to be more transparent generally... we'll have to see how it impacts the implementation of monetary policy.

One last thing to note is the stark comparison for how the Bernanke Fed uses information to transmit monetary policy and affect behavior versus the way that every other Fed administration has.  Obviously they've been much more vocal and transparent.  One could compare if the public has been more sensitive and responsive to changes in the money supply when they are expecting it and understand the reasoning better or when it just occurs without comment.  I think this would be an good research project.