Plosser: Fed Should Offer More Clarity on Potential Policy Moves

A top Federal Reserve official proposed more transparency in the central bank’s policymaking, which he argued would make policy more effective.

In a speech to economists in Washington, D.C., Charles Plosser, president of the Federal Reserve Bank of Philadelphia, said Thursday that the central bank should give consumers, investors and businesses more information about economic forecasts officials may plug into their policymaking and more guidance on how and when the might react to them if they prove accurate--which also would provide signals to how they might react if their projections don't come to pass.

"The better the public and the markets understand how policy is likely to be adjusted as the economy changes, the more predictable policy becomes, which promotes price stability and better economic outcomes," Plosser said.

He urged his colleagues to consider in a more "rule-like way" to set policy, with a "systematic" approach that that incorporates the relationship "between changes in economic conditions and the policy actions and choices" the Fed makes.  He added that increased transparency also could enhance the central bank's credibility and accountability.

In an interview with FOX Business after the speech, Plosser said the Fed's policy-setting body, the Federal Open Market Committee, could disclose its general expectations for future economic conditions--such as levels of gross domestic product, unemployment or inflation--and the likely policy responses to those conditions, such as the level at which it might set short-term interest rates.

“We can be descriptive about that...what conditions would have to exist or how would the economy have to evolve before we would take some kind of step or action...either (to) tighten policy or loosen policy," he said.

“The more we can describe how, when we will react to movements in these variables or can explain our actions in a way that comes from movements in those variables, then people get a better understanding of what we’re looking at and how we’re thinking about policy."

"The more we can be clear about that and signal that in advance, then people understand, 'Oh, OK--they're not going to do this now because things didn’t change,” Plosser said. "When we reduce the uncertainty about monetary policy, we reduce volatility in the economy  – certainly in the markets – and we induce stability for the economy more broadly.”

Plosser said that while the Fed would, under his proposal, offer more clarity in its policy communications, the Fed would not lock itself into set prescriptions: "Policymakers do not know with certainty how economic conditions will evolve.  So they cannot and should not say with any certainty what policy will be in the future...At times it may be important for policymakers to deviate from the guidelines.  But then they will be forced to explain why they deviated and when they anticipate returning to more normal operating practices.  Requiring this type of transparency raises the bar that policymakers face to engage in discretionary policies in the first place."

Plosser did not put a timetable on his proposals, noting that improving transparency and formulating communications strategy is an ongoing process at the central bank--"a journey." But he said "it does seem feasible" that FOMC members "could agree on a set of economic variables to which economic policy should react" because of "growing literature on robust rules that work well."

"We would not have to specify the precise mathematical rule but would provide assessments of key variables and then communicate our policy decisions in terms of changes in these key variables," he said.

You can read his entire speech here.

The Fed has gradually become more open in its policymaking over the last two decades, most recently approving quarterly press conferences for Chairman Ben Bernanke, disclosing more information about FOMC members policy path assumptions and adopting an explicit inflation target, now 2%.

Bernanke has advocated and pushed for more openness at the Fed, but some moves have come under Congressional criticism of the Fed's historically secretive policy deliberations, especially in its handling of the 2008 financial crisis.