A higher interest rate under current conditions is also consistent with the way the FOMC has responded to economic conditions and inflation over the last few decades. This historical pattern of behavior has conditioned public beliefs about how the FOMC is likely to behave in the future, and it has been an essential foundation for the monetary stability we currently enjoy. Further delay would be a departure from a pattern of behavior that has served us well in the past. The historical record strongly suggests that such departures are risky and raise the likelihood of adverse outcomes.

Accountabilityin any endeavor, including monetary policyis not about what actions have been taken. Rather, its about the results those actions achievespecifically, how well performance accords with the relevant objectives. Accordingly, my discussion of FOMC performance and plans is relentlessly goal-oriented.

My goal-oriented approach to FOMC accountability differs from the approach taken in legislation about monetary policy accountability that is currently under consideration by Congress. The Federal Reserve Accountability and Transparency Act (or FRAT Act) would require the FOMC to tell Congress and the public how the Committee plans to change the level of monetary accommodation in response to macroeconomic developments. A key element of the FRAT Act is a reference policy rule that would be intended to serve as a baseline for this communication. The rule frames accountability in terms of what choices the Committee is making, as opposed to how the macroeconomy is performing relative to FOMC objectives. In my discussion, Ill explain how this approach to accountability means that the reference policy rule in the FRAT Act would be likely to degrade, rather than enhance, the FOMCs ability to achieve its objectives.
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To be clear, the proposed legislation allows for the FOMC to deviate from the reference policy rule. However, the legislation views deviations from the reference policy rule as being undesirable. (In particular, it requires the FOMC to provide Congress with a detailed justification for any departure from the reference policy rule within 48 hours.) My point is that this perspective is flawed, because the reference policy rule does not allow for the possibility that the natural real rate of interest varies over time.

The science of monetary policy has not progressed to the point where we can specify the optimal rule for setting monetary policy. The reason is that optimal rules, that is, those that maximize economic welfare, are highly dependent on the particular model from which they are derived, and there is no broad-based consensus for the right model. More relevant is the finding that the optimal rule for one model can produce very bad outcomes in another model. In addition, optimal rules can often be quite complex, thus making them difficult to implement and to communicate to the public. In other words, they may not be very transparent.

However, these limitations to implementing optimal policy rules should not deter us from efforts to adopt a more systematic rule-like approach to the conduct of policy. There has been a great deal of progress made in identifying simple rules that appear to perform well in a variety of models and environments. Such robust rules can form a basis for developing more systematic, rule-like policymaking.

One important and desirable characteristic of a systematic and rule-like approach to policy relates to communication. In particular, it is an approach that is easily communicated to the public and thus greatly improves the transparency and predictability of monetary policy, which reduces surprises. The public and markets are more informed about the course of monetary policy because they understand how policymakers are likely to react to changing economic circumstances. Equally important in my view is that greater clarity about the policymakers' reaction function strengthens accountability and thus can serve to preserve the central bank's independence.

An End the Fed demonstration took place outside my office last Saturday on Main Street in Kansas City, Missouri. It was a reminder that democracy demands accountability from its most powerful institutions to its citizens. The Federal Reserve is no exception.

Unless the python that is the U.S. economy can quickly pass the recent burst of cost-push pressures, we risk a reinforcing spreading of inflationary impulses and expectations. Should this happen and the Fed were to fail to address it, we would run the risk of losing the public’s confidence in our ability to constrain inflation. Then the great editorial writers in this country, to say nothing of Congress and the American people, will be calling for all of us—doves and hawks alike—to be shot (metaphorically speaking, of course).

Another interesting example, which I do not have time to discuss in detail here, occurred with the granting of operational independence to the Bank of England in May 1997 after it had adopted an explicit numerical inflation objective.²³ In explaining the decision to grant operational independence to the Bank of England, the government specifically pointed to the Bank's successful performance in providing forecasts and clear explanations of the likely effects of a range of policy alternatives, thereby increasing accountability and making the central bank more responsive to political oversight.

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. 

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.

     As you know, this occasion marks the 30th year of semi-annual testimony on the economy and monetary policy for the Federal Reserve.  In establishing these hearings -- Mr. Hawkins and Humphrey were mentioned -- the Congress proved prescient in anticipating the worldwide trend toward greater transparency and accountability of central banks in making monetary policy. Over the years, these testimonies and the associated reports have proved an invaluable vehicle for the Federal Reserve's communication with the public about monetary policy, even as they have served to enhance the Federal Reserve's accountability for achieving the dual objectives of maximum employment and price stability set for it by the Congress.

Greater transparency with regard to Federal Reserve actions encourages public discussion and informed scrutiny, important aspects of accountability in a democratic society.  Transparency also enables financial markets to better predict monetary policy decisions, which can contribute to improved policy outcomes.  However, providing more complete information about policy decisions is not without cost.  Transparency requires careful attention by policymakers, and so constrains the time they have for actually making decisions.  More importantly, excessive transparency could inhibit policymakers, making them less spontaneous in their remarks and less willing to explore new ideas.  Such an outcome would have adverse effects on policy decisions.  The Federal Reserve's current practices strike a reasonable balance between transparency and the degree of confidentiality appropriate to support the policy process.

This increase in transparency is highly welcome, for many reasons. Perhaps most important, as public servants whose decisions affect the lives of every citizen, central bankers have a responsibility to provide the public as much explanation of those decisions as possible, so long as doing so does not compromise the decisionmaking process itself. A more open policymaking process is also likely to lead to better policy decisions, because engagement with an informed public provides central bankers with useful feedback in the form of outside views and analyses.