Wednesday, March 4, 2015

Federal Reserve Communication with Congress

In 2003, Ben Bernanke described a central bank's communication strategy as "regular procedures for communicating with the political authorities, the financial markets, and the general public." The fact that there are three target audiences of monetary policy communication, with three distinct sets of needs and concerns, is an important point. Alan Blinder and coauthors note that most of the research on monetary policy communication has focused on communication with financial markets. In my working paper "Fed Speak on Main Street," I focus on communication with the general public. But with the recent attention on Congressional calls to audit or reform the Fed, communication with the third audience, political authorities, also merits attention.

Bernanke added that "a central bank's communications strategy, closely linked to the idea of transparency, has many aspects and many motivations." One such motivation is accountabilityFederal Reserve communication with political authorities is contentious because of the tension that can arise between accountability and freedom from political pressure. As Laurence Meyer explained in 2000:
Even a limited degree of independence, taken literally, could be viewed as inconsistent with democratic ideals and, in addition, might leave the central bank without appropriate incentives to carry out its responsibilities. Therefore, independence has to be balanced with accountability--accountability of the central bank to the public and, specifically, to their elected representatives. 
It is important to appreciate, however, that steps to encourage accountability also offer opportunities for political pressure. The history of the Federal Reserve's relationship to the rest of government is one marked by efforts by the rest of government both to foster central bank independence and to exert political pressure on monetary policy.
It is worthwhile to take a step back and ask what is meant by accountability. Colloquially and in academic literature, the term accountability has become "an ever-expanding concept." Accountability does not mean that the Fed needs to please every member of Congress, or even some of them, all the time. If it did, there would be no point in having an independent central bank! So what does accountability mean?  A useful synonym is answerability. The Fed's accountability to Congress means the Fed must answer to Congress-- this requires, of course, that Congress ask something of the Fed. David Wessel explains that this can be a problem:
Congress is having a hard time fulfilling its responsibilities to hold the Fed accountable. Too few members of Congress know enough to ask good questions at hearings where the Fed chair testifies. Too many view hearings as a way to get themselves on TV or to score political points against the other party.
Accountability, in the sense of answerability, is a two-way street requiring effort on the parts of both the Fed and Congress. Recent efforts by Congress to impose "accountability" would clear Congress of the more onerous part of its task. The Federal Reserve Accountability and Transparency Act introduced in 2014 would require that the Fed adopt a rules-based policy. The legislation states that "Upon determining that plans…cannot or should not be achieved, the Federal Open Market Committee shall submit an explanation for that determination and an updated version of the Directive Policy Rule.”

In 1976, Senator Hubert Humphrey made a similar proposal: the president would submit recommendations for monetary policy, and the Federal Reserve Board of Governors would have to explain any proposed deviation within fifteen days. This proposal did not pass, but other legislation in the late 1970s did change the Federal Reserve's objectives and standards for accountability. Prompted by high inflation, the Federal Reserve Reform Act of 1977 made price stability an explicit policy goal. Representative Augustus Hawkins and Senator Humphrey introduced the Full Employment and Balanced Growth Act of 1978, also known as the Humphrey-Hawkins Act, which added a full employment goal and obligated the Fed Chair to make biannual reports to Congress. It was signed into law by President Jimmy Carter on October 27, 1978.

The Humphrey-Hawkins Act, though initially resisted by FOMC members, did improve the Fed's accountability or answerability to Congress. The requirement of twice-yearly reports to Congress literally required the Fed Chair to answer Congress' questions (though likely, for a time, in "Fed Speak.") The outlining of the Fed's policy goals defined the scope of what Congress should ask about. In terms of the Fed's communication strategy with Congress, its format, broadly, is question-and-answer. Its content is the Federal Reserve's mandates. Its tone--clear or obfuscatory, helpful or hostile--has varied over time and across Fed officials and members of Congress. 

Since 1978, changes to the communication strategy, such as the announcement of a 2% long-run goal for PCE inflation in 2012, have attempted to facilitate the Fed's answerability to Congress. The proposal to require that the Fed follow a rule-based policy goes beyond the requirements of accountability. The Fed must be accountable for the outcomes of its policy, but that does not mean restricting the flexibility of its actions. Unusual or extreme economic conditions require discretion on the part of monetary policymakers, which they must be prepared to explain as clearly as possible. 

Janet Yellen remarked in 2013 that "By the eve of the recent financial crisis, it was established that the FOMC could not simply rely on its record of systematic behavior as a substitute for communication--especially under unusual circumstances, for which history had little to teach" [emphasis added]. Imposing systematic behavior in the form of rules-based policy is an even poorer substitute. As monetary begins to normalize, Congress' role in monetary policy is to question the Fed, not to bully it.

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