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.

Thomas Sargent & Christopher Sims win the Nobel Prize

Thomas J. Sargent of New York University and Christopher Sims of Princeton University won the Sveriges Riksbank Prize in Economic Sciences in the Memory of Alfred Nobel.  They won for "rational expectations," but the official reason given was for "their empirical research on cause and effect in the macroeconomy."

Sveriges Riksbank in Stockholm (photo: Björn Sahlberg)

The idea of "rational expectations" first  won the Nobel Prize with Robert Lucas, Jr. in 1995.  Its exciting to see more proponents of it get the award.  One of the earliest and important anthologies of the idea was published in 1981 and edited by Lucas and Sargent, Rational Expectations and Econometric Practices.  It includes most of the important essays on the subject by Sargent, Sims, Lucas, Robert Barro, Bennett McCallum, Lars Hansen, Stanley Fischer, Gregory Chow, and others.  Another book that I own by Sargent is titled Rational Expectations and Inflation.  I think it's also a bit exciting that the Swedish central bank (Sveriges Riksbank) is concerned about expectations and inflation at a time just after they reduced lending rates into negative territory, although I'm not sure how much the prize and the bank actually co-mingle.

I must admit that I am not as familiar with Christopher Sims, although I have seen his name around the citations and speaker lists.  According to Microsoft Academic Search, his most cited article (by far) is "Macro-Economics and Reality" which is about to Vector AutoRegression (VAR) techniques.  This should also be considered a win for the Univeristy of Minnesota economics department.  While neither professor is currently there, both did some of their most crucial work on rational expectations there.

These names were, at first, a bit suprising to me.  They made my short list, albeit the long version of my short list.  They did not attract any interest from my short list when I initiated my poll.  I must admit that I'm very happy that some more rational expectations economists are winning, but I'm a bit shocked that Robert Barro didn't win along with them.  I hope the recent controversy didn't prevent him from being added, although I'd be suprised if that was the deciding factor.

News Conference at Princeton University with Thomas Sargent & Christopher Sims

You can offer the candidates your congratulations via the Nobel website.

The Robert Barro Controversy

Robert Barro (Harvard University) recently wrote an op-ed for the New York Times titled "How to Really Save the Economy."  In it he describes the U.S. economy as anemic and calls for austerity to fix the problem.  Not that fiscal austerity will create economic growth, but that a more fiscally stable government would promote investment.  He writes, "What drives investment?  Stable expectations of a sound economic environment, including the long-run path of tax rates, regulations and so on."

Robert Barro (photo: Luis Rodas)

For some time now, I've wanted to write an article attempting to address the question, 'Why isn't the U.S. a good place to invest anymore?'  Many of our banks and corporations have lots of cash, but they do not believe that they will get a good return on their investment right now.  How do we fix that problem?

Keynesians would argue that government should simply make up the difference in aggregate demand to return the economy to the edge of the production possibilities frontier.  I've never liked that argument very much as I think the production possibilities frontier to be a bit of an economists' fantasy.  I think Barro's analysis of the problem in terms of tax and regulatory environment are good takes on the investment situation.  I don't know that I agree with his solutions (Federal VAT tax in lieu of Federal corporate and inheritance taxes), but I've seen much worse in recent months and years.


Paul Krugman (Princeton University) called Barro's work lazy!  Tyler Cowen (George Mason University) wrote that a negative approach to the Solow model might be what Barro is writing about.  I think Cowen's referring to a negative approach to the Solow residual.  I think the exogenous growth model (Solow model) actually defines tax policy as only affecting short term growth, whereas Barro was writing about short and long term growth (I think).

Greg Mankiw (Harvard University) on Paul Krugman's response.

Because Krugman's column was so dismissive and smug, it really got under my skin.  Most of the comments were even worse.  One individual wrote "Perhaps he cannot make a coherent argument."  He's one of the most frequently cited economists today!  This is ridiculous!  I added this comment at his site:

"Robert Barro was writing in The New York Times, not the American Economic Review. He was writing for an audience that doesn't necessarily understand all of the nuances of academic economics, but still desires to be part of a serious discussion of our future from that point of view.


You, more than most, should be able to recognize that his column falls well within the scope of his previous works. He has been writing about the effect that government spending has on the economy and the monetary system since the 1970's. He sits alongside Ben Bernanke, Thomas Sargent, Frederic Mischkin, Allan Meltzer, John Taylor, and a handful of others as an eminent monetary economics scholar.


You show Dr. Barro extreme disrespect in this article. He may have been writing for the lay person, but you should have been able to tie his column to his previous work because of your background in the field."

Krugman also recently authored another, even more controversial, column on the anniversary of 9/11.