The views expressed are mine and do not necessarily reflect the views of the Board of Governors or the Federal Reserve Bank of St. Louis Daniel L. Thornton Vice President and Economic Advisor Federal Reserve Bank of St. Louis Remarks Prepared for Central Bank Communication, Decision-Making and Governance Wilfrid Laurier University April 27, 2009

“Monetary Policy Transparency: Transparent About What?” The Manchester School, September, 2003, Transparency is good if it enhances the efficacy of monetary policy and bad if it doesn’t  Secrecy does not imply lack of democratic accountability  If whatever the CB is being transparent about doesn’t affect the efficacy of MP, then as a general rule, more transparency is preferred to less

2. The extent to which policymakers may want to be secret depends on both the economic environment and the objectives of policy  The economic environment determines the set of feasible objectives as well as whether transparency is good or bad  Policymakers choose among the feasible set of objectives to optimize some (societal) objective function

What is the feasible set for inflation and output growth?  If there is no effect of MP on output in the long run, the long run the feasible set consists only of inflation  If policymakers believe that there is a permanent tradeoff between inflation and output growth, they need to say what the tradeoff is and why it exists

What is the feasible set for inflation and output growth?  In an economy where the variance of inflation and the variance of output are positively correlated or when all cyclical shocks are demand shocks, inflation stabilization and output stabilization are complements (not substitutes)

Assume Note that Assume that,, which implies, so that the optimal choice of lambda is zero

 Economic stabilization and inflation stabilization are not complements when there are supply shocks  There is a question of whether the CB should response to supply shocks and how aggressively it should respond  The CB should be clear about when and how it will respond to supply shocks

 While there is evidence that bring inflation down from high levels requires temporary reductions in output, evidence that maintaining inflation at a low rate requires an output sacrifice is hardly compelling

 CB’s use of the tradeoff between “stabilizing” inflation and output depends on (a) the existence of a relatively stable short-run Phillips curve (the evidence, e.g., Stock and Watson, 2008 is not compelling), and (b) the ability of central bankers to exploit that tradeoff  tradeoff is variable and not predictable  variable lags in the effect of MP on output and inflation  measurement problems, e.g., potential, NAIRU, etc.

1. CBs need to be explicit about their objective function and their view of the feasible set of policy objectives and the extent to which they believe they can achieve these objectives  in particular, CBs should be very specific about their view of the “optimal” inflation rate and why this rate is optimal  they should state whether the optimal inflation rate is state dependent and, if so, how and why it changes  if the optimal inflation rate is positive, they should explain why is a little inflation is desirable

2. Having an explicit numerical inflation objective is critical to anchoring inflation expectations  A numerical inflation objective is a constraint on too zealous pursuit of economic growth by policymakers and government officials. Economic growth is often euphemistically called “output stabilization” by those who believe the optimal rate of inflation is higher that the CB’s target rate)

3. CB’s should be forward guidance about their target for the long-run inflation rate, but not about the policy rate, monetary aggregate growth or other instruments that move endogenously with economic activity  Forward guidance on the policy rate is not credible (e.g., Anderson and Hoffman, 2009). Economic variables are too hard to predict.