Unconventional: A Policymaker's Reflections on Crisis to Recovery
"Along with others on the FOMC, Jim Bullard was a proponent of adopting an explicit inflation target in the U.S. years before it was officially implemented in 2012. He was part of a group of Fed presidents who helped craft the language that led to the FOMC's 'Statement on Longer-Run Goals and Monetary Policy Strategy,' which is where the inflation target is stated. In addition, Bullard was, and continues to be, an advocate of defending the 2 percent target from the high side and the low side."
—Christopher Waller, Executive Vice President and Director of Research
James Bullard shared some reflections on his first 10 years as Bank president during recent conversations with staff. The following are excerpts from those discussions.
The U.S. lagged many other central banks around the world in adopting an explicit inflation target. The FOMC didn’t name one until January 2012. This was a step toward increased Fed transparency and something that I and others had long advocated.
The European Central Bank is an example of a central bank that has long had an inflation target. In fact, the ECB has had one since it was established in 1998. There were many years during the run-up to the ECB's establishment to decide various aspects of adopting an inflation target—e.g., what the number would be, the horizon over which the central bank would be expected to achieve that number, the index used to measure inflation and the exact wording for the target.
Ben Bernanke, who became Fed chairman in 2006, had wanted the FOMC to implement an explicit inflation target for the U.S. Many others on the FOMC were also supportive of an inflation target. There was some talk that the FOMC would simply need to put a number in the post-meeting statement. Others, including me, thought this did not go far enough, that other issues related to naming a specific number also needed to be addressed—i.e., the issues that were the focus of discussion in establishing the ECB.
To that end, in early 2011 an ad hoc group of Federal Reserve bank presidents assembled—five of us—whose views on monetary policy spanned the spectrum of opinion on the FOMC. Rather than putting a number in the FOMC’s post-meeting statement, we drafted a separate one-page statement that not only would name an inflation target for the U.S., but would touch on other important issues. It said that the FOMC, given the Fed’s dual mandate, would follow a balanced approach between the real side of the economy (e.g., employment, output) and the nominal side of the economy (e.g., prices). It named an inflation target of 2 percent, and it explained why a similar target for the employment side of the mandate was not specified. (Monetary policy controls inflation over the medium to longer run, but it does not control employment over that horizon.)
The proposed statement was vetted extensively over several months by other Reserve bank presidents, Chairman Bernanke and other members of the Board of Governors.
Ultimately, at its January 2012 meeting, the FOMC adopted a very similar statement as part of the formal process of the meeting, which is how we got an explicit inflation target. Under current protocol, the FOMC revisits the statement every January. Chairman Bernanke’s goal of naming an official inflation target for the U.S. was achieved, and the FOMC’s diverse views, collegial approach and disciplined vetting had served it well.
At the outset, the Federal Reserve Act of 1913 did not give the Fed an explicit monetary policy mandate—although the goal in creating the U.S. central bank was to promote economic and financial stability for the nation.
Following the Great Depression and World War II, Congress passed the Employment Act of 1946, requiring the federal government "to promote maximum employment, production and purchasing power."
In response to the Great Inflation of the 1970s and ensuing recession, the Full Employment and Balanced Growth Act of 1978 (referred to as the Humphrey-Hawkins Act) was introduced, making the federal government responsible for achieving full employment and price stability, among other goals.
In 1977, Congress amended the Federal Reserve Act, directing the Fed to "increase production, so as to promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates." The first two—maximum sustainable employment and price stability—are commonly referred to as the Fed's dual mandate.
Long before the dual mandate was law, an idea took hold in the 1950s that there is an inverse relationship between unemployment and inflation. This relationship (named the Phillips curve, for economist A.W. Phillips) suggests that the lower the unemployment rate is, the higher wage growth (i.e., wage inflation) is likely to be. The theory is that this wage inflation would then get passed on by firms to customers via higher prices (i.e., price inflation). It was generally viewed that policymakers could exploit the trade-off between inflation and unemployment by setting policy that could raise one variable at the cost of the other.
The Fed and other central banks are still guided, in part, by the Phillips curve in making monetary policy. However, the idea hasn’t always held up in practice—especially in the stagflation era of the 1970s (when unemployment and inflation were high) and in today's environment (when unemployment and inflation are low). This has many monetary policymakers, including James Bullard, pointing to the “disappearing Phillips curve.”1
"The evidence since then has accumulated even more than it already had at the time in the 1970s—that there was no automatic, permanent trade-off between inflation and unemployment and that you could keep inflation low and stable without adverse consequences for the real economy in the medium to the long run," Bullard said.
While monetary policymakers can influence the real economy temporarily, he noted, they cannot control real variables like employment, output growth, consumption growth and investment over the medium term. "These are going to be defined ultimately by markets interacting, by supply and demand all across the economy and by specific markets—real decisions by real people," Bullard said. "The Fed can't change that.
"The central bank can control the inflation rate over the medium term, and because of that, I think it'd be better to have a single mandate," he said. "The optimal way to deliver on the dual mandate is to pursue low and stable inflation, which in turn helps the real economy."2