As a consequence of observing this process for 10 years, I have concluded that an FOMC attempt to provide forward guidance in the policy statement causes more communications difficulties than it solves.  A key reason is that the economy is subject to more shocks and reversals than one might think. ... Directional language tends to remain in the FOMC policy statement beyond the time it applies and removing the language creates the possibility of miscommunication.  Every change in the policy statement leads naturally to market questions as to what the change means and whether the change is meant to provide a hint about the future direction of policy.  To my mind, every time new language is inserted into the policy statement, there needs to be as much thought given as to how to exit from the language as to the rationale for inserting it. 

When I came to the St. Louis Fed, I was well prepared for my FOMC responsibilities in most respects. I knew a lot about monetary economics and monetary history. What I did not know was the art of communicating with the press and general public. The professional literature in economics was full of insights into the importance of private-sector expectations about monetary policy but essentially silent on how those expectations were formed, except for the assumption that expectations would not be systematically wrong and would converge to being correct eventually. Once I started fielding questions from the press after my speeches and talking informally before a wide range of audiences, I was part of the process of trying to establish correct expectations.

My general approach has been to speak primarily about the policy process rather than the specific situation facing the FOMC at its next meeting. I try to think of myself as speaking to portfolio managers who have a medium-term horizon rather than to traders who have a horizon measured in hours or a few days. I do not disparage traders—they perform an important function. Obviously, I have had internal information that would be of interest to traders but it would be entirely inappropriate—indeed illegal—to disclose confidential FOMC information.

Traders, portfolio managers and many others always want to know my forecast of what will happen at the upcoming FOMC meeting. My standard answer is that I do not forecast monetary policy decisions—my job is to participate in making those decisions. I confess that, initially, this response was something of a dodge, because I usually had a pretty good idea weeks in advance of what my own position at a meeting would be. However, over the years I have become impressed by how often my own position would change even in the days just before a meeting as a consequence of the arrival of new information, including staff analysis and sound arguments by my FOMC colleagues

For most of our history, the Federal Reserve did not announce any policy moves, choosing instead to let the world guess at our policies by carefully reading the financial market indicators. But gone are the days when central banks find it advantageous to operate in secret.

The Term Auction Facility seems to address a liquidity need, and we're continuing it because that liquidity need is still there. ...  
My sense is there's a preference for using the Term Auction Facility as a mechanism, and also because it doesn't carry the same stigma content. ... The communication has been quite adequate. I would defend the communication practices and policies that we've carried out in the last few weeks. From press Q&A session, as reported by Market News International

Good communication is essential to successful central banking.  It is critical to preserving the democratic accountability and public legitimacy of central banks that, for good reasons, have been granted a high degree of insulation from short-run political pressures.  And good communication strengthens the effectiveness of good policy, largely because expectations are so important to the choices that households and businesses make about spending and saving and about prices and wages, as well as to the asset prices that help shape those choices.  Private decisions are more likely to reinforce the achievement of central bank objectives if decisionmakers understand the goals of the central bank, its evaluation of the forces bearing on the economy, and its possible responses to economic shocks. 

Because the situation has been so fluid and so uncertain in its effects, the speeches of individual FOMC participants have given varied interpretations of the developments and their implications for policy.  The resulting dispersion of messages has bothered market participants seeking clear, unambiguous guidance about the views of the central bank.  The public should understand that the FOMC members do not coordinate schedules and messages, and that members' views are likely to be especially diverse when, as in the current situation, circumstances are changing quickly and are subject to many different analyses.  The diversity of views on the Committee is one of its strengths and vital to arriving at sound decisions.  

I like the way we came out in the last statement, similar to the statement in September: an agnostic view of the balance of risks. I have some concerns about our use of this balance of risks language. It has served a purpose at times but can also put the committee in an awkward position. Markets often use our balance of risks to infer something about what they think the path of the funds rate is going to be and that is not I believe the best way to do business. I would like us to be more
explicit about how the evolution of the economy impacts our decisions, rather than signaling the path of the funds rate.

The circumstances have focused my attention on this language issue, particularly in the balance of risks and I suspect people are struggling right now with, `Okay, maybe we have to think through this a little more carefully than we had before.’ In the current circumstance it makes sense [not to state the balance of risks] and I’m thinking about what else can we say that might improve our communications.

It is important to recognize that providing more information on our forecasts does not represent a new way to do policy. Rather, it helps clarify what the Committee is focused on. It also makes more explicit that the Committee is looking forward, does have a plan to pursue its dual mandate, and is attentive to situations where the risks to its forecast may be unusually large or asymmetric.

Now let us take a brief look at the Federal Reserve's macroeconomic projections for 2007 through 2009. These projections are useful for understanding the Federal Reserve's near-term policy strategy, and again, I would like to highlight how this strategy fulfills the dual mandate and embeds key implications of the modern science of monetary policy.

The science emphasizes that monetary policy makers need to think in terms of a plan for the appropriate paths for inflation and economic activity that best promotes the dual mandate of price stability and maximum sustainable employment. If economic activity is well below its maximum sustainable level, then monetary policy should aim at increasing output and employment toward sustainable levels. If inflation is above the mandate-consistent rate, monetary policy should aim at reducing inflation to that rate. Providing projections for the short run as well as for the longer run encourages FOMC participants to think in terms of desirable paths for inflation and output, a discipline that the science suggests will produce better policy outcomes. In addition, the projections provide households and businesses with information that can help them understand what the monetary authority is trying to achieve, thereby increasing the likelihood of good economic outcomes.

The Federal Reserve, for example, pays particular attention to the rate of growth of the core personal consumption expenditure (PCE) deflator, which excludes food and energy prices.  Indeed, in the presentation of its twice yearly Monetary Policy Report to the Congress, the Federal Reserve Board reports the projections of Federal Open Market Committee participants regarding core PCE inflation, not headline inflation, the latter of which includes all items in the price index.  Here in Canada, unlike in the United States, the central bank maintains an explicit inflation target.  The Bank of Canada states its target in terms of the headline consumer price index, and although this choice of inflation measure contrasts with the Federal Reserve's preferred index, the difference is not nearly as great as it appears on the surface.  In fact, the Bank of Canada monitors a number of inflation measures and uses core inflation as an "operational guide" in coming to its monetary policy decisions and discussing these decisions with the public. 

An important corollary to the task of defining a policy rule is that the central bank ought not to be a source of random disturbances. All of us are well aware of the potential for saying things inadvertently that will create market misunderstanding of likely Fed future policy actions. ... One way to avoid misinformation is to avoid providing any information. Put another way, if my mouth is not open, I cannot put my foot into it.

In my view, however, it is important to try to convey correct information. I do not believe that I would be doing my job if fear of providing misinformation led me to provide no information. For this reason, I have maintained an active speaking schedule.

Fed policymakers, on the other hand, do not continuously adjust the stance of policy in the same way managers adjust portfolio holdings. For this reason, my own practice is not to worry much as to whether I have correctly absorbed the import of each day’s, or each hour’s, data. I know that some information will be irrelevant to my policy position because it will be by new information by the time of the next FOMC meeting... Given that the FOMC does not adjust policy continuously, updating my forecast with every data release would not be an efficient use of my time.

A consequence of the fact that FOMC meetings occur at six-week intervals, on average, is that when I give a speech and take questions I may not be completely up to date on the implications of the latest data. In my speeches and discussions of policy with various audiences, I try to concentrate on longer-run issues and general principles. I emphasize that I will be studying all the data and anecdotal information in the days leading up to an FOMC meeting. Thus, I ordinarily do not give detailed answers to questions on the precise implications of the latest data for the economic outlook. In many cases, I just haven’t studied the implications thoroughly, although I certainly do so by the time the FOMC next meets.

It is highly desirable that the central bank behave in a rule-like way, both for the political objective of the rule of law rather than the rule of men and because predictable policy promotes more efficient decisions in the private sector. To the maximum possible extent, we desire an equilibrium in which the markets behave as the central bank expects and the central bank behaves as the markets expect. Central bank behavior to anchor expectations of low and stable inflation is the single most important aspect of policy predictability. I believe that the Fed has come a long way in that direction though, obviously, there are certainly opportunities for the Fed to refine its policy rule. In this context, by “rule” I simply mean that the Fed’s policy actions are systematic and highly predictable responses to new information.

For instance, in the wake of Hurricane Katrina in late 2005, markets’ immediate response to rising energy prices suggested expectations of persistently rising inflation. Market participants, it seems, were uncertain as to how much of a run-up in general inflation the Fed would allow. Inflation expectations moved back down after a number of FOMC members made speeches emphasizing their focus on preserving low inflation. This episode illustrates both the potential for the Fed to influence inflation expectations and the extent to which market participants are at times uncertain as to how the Fed will respond to new developments.

There's a general view out there that I have more influence than I know I have.  I get accused of inducing market changes, really because I was standing next to the market when something else happens.

As reported by the Washington Post