Shadow Open Market Committee Statement on Bernanke’s June 21 Press Conference

June 21, 2011

The Shadow Open Market Committee has long advocated increased transparency in the Federal Reserve’s communications with the public. We commend Chairman Bernanke’s thoughtful initial press conference on April 27, 2011 for creating an additional gateway for deepening our understanding of the Federal Open Market Committee’s (FOMC’s) monetary policy decisions and its views on the economy.

A critical aspect of the initial press conference was the Chairman’s discussion of the FOMC’s monetary policy stance in light of medium term projections for at or below trend economic growth and continued elevated levels of unemployment. These sobering projections, in light of the Fed’s unprecedented expansive monetary, credit, and interest rate policy since the crisis began, are testimony to the limits of what monetary policy can achieve in generating economic growth and jobs in the medium to long term.

As stated in our prior statement on April 27, 2011, we re-iterate that:

“Although effective communication is an essential component of monetary policy, communication itself can only clarify and reinforce clearly-stated strategic policy objectives and guidelines for how the Federal Reserve intends to achieve its objectives. Communication cannot substitute for a lack of clarity about objectives or about plans for realizing those objectives.”

The Shadow Open Market Committee recommends that the Fed continue to clarify its objectives and guidelines as follows to facilitate communication with the media and the public via the Chairman’s press conferences.

First, the Chairman should formally announce the FOMC’s commitment to an explicit “mandate-consistent” rate of inflation that it uses as its long run objective for its policy deliberation. At the same time, the Fed should articulate its strategic framework for credibly delivering a low inflation environment based upon the view stated by Chairman Bernanke at the April 27th, 2011 press conference that, “In contrast to economic growth and unemployment, the longer-run outlook for inflation is determined almost entirely by monetary policy.” The Chairman should also specify the Fed’s method for measuring progress towards its inflation mandated target and over what time horizon it wishes to meet this target.

It is long overdue for the FOMC to adopt a credible inflation targeting framework. The Shadow Open Market Committee continues to recommend that the Fed formally and unilaterally adopt a priority for targeting low inflation as necessary “operationally” to achieve best outcomes for both inflation and unemployment over the longer run. We believe that such a step, while potentially controversial, fulfills the Fed’s obligation to the dual mandate since only by creating a low inflation environment can the Fed create the environment for maximum employment.

The current high unemployment rate in the U.S. primarily reflects structural issues that are beyond the Fed’s limitations, which draws attention to the need for clarification of the dual mandate. The Shadow Open Market Committee’s recommendation that the Fed adopt a priority for targeting low inflation as the means to fulfill the dual mandate follows the best practices of monetary policy adopted throughout the world, and is informed by Fed’s policy failures in the 1970’s and its subsequent successes in later decades. Indeed, as then Governor Bernanke stated in his March 25, 2003 speech, an inflation targeting framework allows “both price stability and well-anchored inflation expectations; the latter in turn facilitates more effective stabilization of output and employment.”

Second, as QE2 arrives at its scheduled close, the Fed should provide both a thorough self-assessment as well as welcome an independent assessment of it for several reasons. First of all, the Fed justified QE2 by indicating it would lower long term interest rates, prevent the threat of deflation, and address the rise in the unemployment rate that was largely cyclical in nature, suggesting insufficient demand in the economy. These claims should be evaluated in light of the historical experience: an initial rise in long term rates, an unchanged employment picture, a modest rise in headline inflation, and an increase in excess reserves held at the Fed that is almost as large as QE2 itself.

Moreover, a thorough post-evaluation of QE2 will help inform the Fed’s eventual exit from its balance sheet expansion. Similarly, it could also inform a potential further expansion of its balance sheet in any subsequent QE3. Indeed, should the FOMC consider at some point in the future to further increase its balance sheet by purchasing additional government securities, lessons learned, even unpleasant ones, will provide a benchmark for sizing QE3 as well as the wisdom for conducting such operations.

Third, as elected members of the legislative and executive branches of the U.S. government wrestle over the political and economic dimensions of fiscal policy, we advocate that Chairman Bernanke emphasize the imperative for fiscal authorities to stand by the “full faith and credit” commitment for US Treasuries. The Chairman should articulate why a Treasury default should be one of the last options ever undertaken by the US government, and the likely consequences that any deterioration of the status of U.S. Treasuries would have on financial markets, financial firms, and our economic well being. The Shadow Open Market Committee continues to advocate for broad fiscal reform that establishes a tax policy that enhances economic supply conditions in the U.S., that cuts wasteful spending, and that establishes a size of government and benefits that reflects our values and allows us to live within our means.

Finally, the Chairman should address what plans the Fed has in place to deal with the ongoing financial crisis in Europe that stems from the possibility of a sovereign debt default or restructuring by Greece and potentially other countries. For instance, what arrangements has the Fed made with the European Central Bank and other Central Banks to address future financial and credit market reactions to the European situation? Second, given that any re-structuring or default on European sovereign debt will trigger large gains and losses in the market for credit default swaps, the Fed should explain what oversight they have put in place to insulate US financial firms it oversees from this exposure?

For more information on the Shadow Open Market Committee, go here.

For more information on the members of the SOMC, go here.