A retrospective conversation with William Poole
Has the FOMC reached a good state in terms of its communication, or do you think there is more work to be done?
There is more work to be done. One of the biggest innovations came in 1994 when the FOMC began to disclose what its policy decision was after each meeting. The communication since then, however, has sometimes been a bit muddled. I don’t think there is a settled view in the FOMC about the value of essentially forecasting policy, or trying to give hints about where you’re going to go. I’ve become skeptical of that approach because I think the correlation between where you go and where you can see yourself going in advance is very low. … I also think that there is unfinished business with regard to clarity of objectives. I’ve been an advocate since the first day I came here of a formal inflation target, and that issue is still unresolved. There is a huge amount of unfinished business in trying to define and communicate the Fed’s reaction function (see explanation). … One of the problems right now is that the FOMC itself doesn’t have its reaction function very well specified. I think more discussion about regularity of the reaction function would be very helpful and would help the communication strategy by narrowing the range of uncertainty so that the FOMC has more predictable policy.
What can the FOMC do to further demystify its actions and decisions?
In the public relations profession, where there is a lot of concentration on communications strategies, people will tell you that you have to be sure of what your message is. You don’t just throw a whole lot of information out there. What are you trying to convey? I think that, to too great an extent, we’ve been throwing information out there without being clear in our minds what the message is. … And the way I’ve made this point in several speeches is that the issue is not transparency, but communication. Transparency implies that you throw back a curtain and let everybody look in. We too often dump the data without explaining what to make of it and why we’re doing it. What we need to do is not increase the material that we put out there, but we need to increase the interpretation and explanation, and we need to clarify the message. I don’t think there is enough of that happening.
Speaking of communication, you have had a reputation as one of the more outspoken Reserve bank presidents, whether it be your willingness to speak on record with the media or the nearly 150 speeches you have given. Why do you feel it has been so important for you to maintain such high visibility?
When I came here and began to give speeches, I asked myself: What exactly am I trying to do? And what purpose is being served? Here I am, out there representing the Federal Reserve, knowing that expectations are very important. And while expectations are obviously intimately connected with policy decisions of the Federal Reserve, they also to some extent reflect what comes out of the mouths, or pens, of Federal Reserve officials. So, I started to think through what to do and how to do it.
Another question I asked myself was: What can I infer and interpret from fluctuations in financial data about inflation expectations or expectations about monetary policy? These are things that are important to Federal Reserve decision-making. I came to the view that I can only make sense of all this if I put it in very simple abstract terms. And that’s where the speech came from in 1999 that was called “Synching, not Sinking, the Markets.” (See sidebar.) I said, let’s go back to the basic literature of the 1970s and the basic macroeconomic model—the rational expectations equilibrium. The desirable equilibrium is that the central bank behaves as the market expects, and the market behaves as the central bank expects. That’s the nature of the equilibrium: When there is new information, such as data on industrial production or housing starts, the equilibrium requires that the Federal Reserve and the markets respond to the same data in the same way. A number of my speeches have been oriented around that theme, and that provides a unifying theoretical view that ties together lots of different problems. For one thing, this view gives me a very easy way to address the questions that keep coming, such as: “How’s the Fed going to set interest rates at its next meeting? What are you guys going to do?” Then I can say, “What we’re going to do will depend on what the new information is. I can’t predict unpredictable information. And you would not want me to commit—you would not want the FOMC to commit—as to what it is going to do come hell or high water. It wouldn’t make any sense for us to ignore important new information.”
I always tell people, “I’m not being coy with you. I’m telling you that I can’t predict what the inflation rate is going to be in next week’s CPI report. If it’s an outsized shock, with no extenuating circumstances to it, then the Fed needs to take that into account when forming its inflation outlook, and that ought to affect our policy decision.”
The rational expectations model says that the market has to understand what the central bank is doing. The market understands what the central bank is doing, in part and maybe even mostly, through inferences from observed central bank actions—how we set the federal funds rate. But the communications strategy can deepen the market’s understanding of what we’re doing and why we’re doing it, and that helps to produce a better equilibrium. That’s the reason to be as open and forthright as possible.
Earlier, you mentioned inflation targeting. Is the announcement of an inflation target being hamstrung and hung up by concern about the Federal Reserve’s dual mandate?
Probably. I think that, putting political pressures, which are real, aside, it’s possible to explain all this easily within the framework of the dual mandate (see explanation). If you look back in history, you see that the largest problems on the employment front have come from inflation and price instability. You look at deflation during the Great Depression, the biggest economic disaster in U.S. history by far, and then you look at the ’60s and ’70s, when inflation was rising, the business cycle fluctuations became more extreme, and the average rate of unemployment rose—and I don’t think it’s an accident that price-level stability and employment levels are connected. So, we ought to be able to explain that achieving sustained, high and stable employment requires inflation stability. We can assist in maintaining inflation stability if we have great clarity as to the objective. That’s an argument that I believe and that I’ve made in some of my speeches. And I don’t see any reason why the FOMC shouldn’t adopt that as its official view.
Switching to an issue that brought a lot of attention to you a few years ago: government-sponsored enterprises (GSEs) like Fannie Mae and Freddie Mac. You made a speech in March of 2003 (page 12) in which you questioned the long-term financial viability of these agencies. Where does this issue stand today?
That speech caused a little stir. I don’t think anything constructive by way of reform has happened since. I don’t take credit for disclosing the accounting irregularities, but when I look back, is there something I wish I had said or not said? The answer is no. One of the reasons I went down that track is that I have a vivid memory when I was at the Council of Economic Advisers in Washington. We had many discussions and were all very well aware of the problems being covered up in the savings and loan industry. That experience led me to rather deep regret that I had not raised that issue publicly. I might not have been in a position to do it because it was a very politically difficult issue, and many people were trying to cover it up, sweep it under the rug and ignore it. But I wish I would have somehow found a way to raise that issue and improve public consciousness. If I had been able to do that in 1982 or 1983, and if there had been some earlier action, it might have saved taxpayers quite a bit of money. It probably wouldn’t have made any difference, but I would have felt better.
So, part of the reason that I did push the GSE issue was a feeling that I was in a position to understand the issue and the potential gravity of it. And that’s exactly what an office like this is for. I have an audience simply by virtue of speaking from this office that I would not have had as a Brown University professor; so, why not? That’s consistent with my predecessors. That’s what Darryl Francis did. (See sidebar.) He went out campaigning about the inflation issue and about monetary policy. He did not change policy at the time, but I think he had very substantial long-run influence on the national debate and on the Federal Reserve System. He had much more impact on dealing with monetary policy issues than I have had to date on the GSE issue.