While both respecifications [suggested by Reifschneider and Williams] improve the performance of the economy during periods subject to the zero nominal bound, they raise a question about the credibility of the commitment implied by the rule. In particular, the effectiveness of such a commitment hinges directly on the ability of the central bank's promise of future actions (perhaps several years into the future) to influence the public's expectations today. In such a case, transparency may offer an important benefit. In particular, if workers, firms, and investors can be convinced through public statements that an unusual situation calls for unusual action, the central bank's ability to affect expectations about its future policy--when the promised future policy is different from its normal conduct--may be enhanced.

The public has a right to know what its unelected, as well as elected, officials are doing, and why. And this is the reason that transparency is so important for supporting the independence of the central bank. Transparency facilitates a broad understanding of what the central bank is doing and thereby gives the public the tools to hold the independent central bank accountable. Transparency, in fact, can play a valuable role in reinforcing the institutional independence of a central bank

If the monetary authority can be clearer about what it is doing now and what it plans to do--not in the sense of setting future moves in stone, but rather in terms of explaining risks that might influence future policy--then market participants can improve their expectations of future short rates. Also, less uncertainty about monetary policy might reduce the premium for uncertainty. Thus, transparency ought to bring the rates that matter most for the macroeconomy into closer alignment with the intentions of monetary policymakers. In effect, greater transparency allows policymakers to work with the market, not against it.

If the public is unclear about the strategy and objectives of the central bank, the credibility of monetary policy may suffer. Current economic developments or policy actions directed toward short-run concerns could have an outsized influence on perceptions regarding the more distant future--especially long-run inflation expectations and, therefore, long-term interest rates. Because such changes in perceptions could be counterproductive, concern about triggering them might discourage a central bank from taking action that otherwise could have been appropriate and beneficial for the economy in the near term. Lack of transparency and lack of credibility, in this sense, could reduce the effectiveness of monetary policy in stabilizing the economy against transitory shocks.

While a 4 to 4-1/2 percent real funds rate may have been appropriate earlier this year when the economy and productivity growth were much stronger and credit conditions were much easier, a lower rate is called for currently. Easing today would be awkward if not embarrassing because of our current bias. However, making an awkward right decision for the economy is preferable to making a face-saving wrong one.

[Note:  The Fed kept rates unchanged on Dec. 19, but announced an intermeeting rate cut two weeks later.]

I remember very well a conversation I had with a very smart financial reporter shortly after I left the Fed. He said that he has learned over the years to ignore what the Fed says and watch what it does. I had to concede that he was right, but it troubled me a great deal that the two would be so different. In my view, they should be a matched pair.