Determining the Fed’s monetary policy needs a systematic approach (Part 1 of 7)
Charles Plosser’s speech on monetary policy at the Council on Foreign Relations
Dr. Charles Plosser, President and Chief Executive Officer of the Federal Reserve Bank of Philadelphia, spoke at the Council on Foreign Relations in New York on May 8, 2014. The topic for discussion was “Communication and Transparency in the Conduct of Monetary Policy.” In his speech, Dr. Plosser explained why a systematic approach to determining the Fed’s monetary policy and communicating the same to financial markets would benefit the economy.
Charles Plosser’s views on transparency in communicating monetary policy
In his speech, Dr. Plosser remarked that the Fed could communicate how the future path of the Fed funds rate can be determined by the use of different Taylor-like rules. “The attractiveness of Taylor-like rules for monetary policy goes beyond their intuitive appeal or the fact that they seem to describe the actual behavior of monetary policy reasonably well,” said Dr. Plosser.
He also discussed how the Federal Reserve Board’s macroeconomic policy analysis tool FRB/U.S., could be used as a basis for generating economic forecasts by applying “rules-based policies.”
Dr. Plosser said, “Systematic policies that provide important information about the policymakers’ reaction function combined with other information, such as the policymakers’ economic forecasts, can sharpen forward guidance in a way that reduces policy uncertainty and enhances economic performance. Thus, well-designed communications are valuable, and behaving systematically has the added advantage of making those communications easier for the public to understand.”
How does the Fed funds rate impact markets?
The Fed funds rate is the main benchmark rate for the U.S. economy and the Fed’s chief monetary policy tool. Consequently, it has important implications for both stock and bond markets impacting ETFs like the iShares S&P 100 ETF (OEF) and the Vanguard Total Bond Market ETF (BND). The iShares S&P 100 ETF (OEF) tracks the S&P 100 Index. The index is market capitalization based on and includes blue-chip companies like Wells Fargo (WFC) and Berkshire Hathaway (BRK-B).
Changes in the Fed funds rate translate to changes in rates across the credit and maturity spectrum, impacting fixed income ETFs like the iShares iBoxx $ High Yield Corporate Bond ETF (HYG), which invests in debt issued by companies which is rated below investment-grade or high-yield. For more on credit ratings, read Credit ratings: Another bubble in the making ?
About the Council on Foreign Relations
The Council on Foreign Relations (or CFR) was formed in 1921. The New York-based institution is an independent, nonpartisan membership organization, think tank, and publisher. The CFR is dedicated to being a resource for its members, government officials, business executives, journalists, educators and students, civic and religious leaders, and other interested citizens in order to help them better understand the world and the foreign policy choices facing the U.S. and other countries. This includes convening meetings at its headquarters in New York and in Washington, D.C., and other cities where senior government officials, members of Congress, global leaders, and prominent thinkers come together with CFR members to discuss and debate major international issues (source:Council on Foreign Relations).
About Charles Plosser
Dr. Charles Plosser has been the President and Chief Executive Officer of the Federal Reserve Bank of Philadelphia since August 2006. He has been a vocal critic of the Fed’s monetary stimulus program and would like to see the end of monthly asset purchases (at $45 billion per month currently) as soon as possible. Dr. Plosser is part of the Federal Open Market Committee (or FOMC) and he’ll be voting on the policy this year.
After the fallout of the 2008 financial crisis, Plosser advocated for the need to preserve the U.S. Federal Reserve’s independence by drawing a distinction between fiscal and monetary policies. He’s also a keen proponent of reform that will end the notion of “too big to fail,” as he believes this notion may lead to the next financial crisis. To know more about Dr. Plosser’s views on financial sector reform, read Why Charles Plosser calls for simplicity in financial regulation.
In the next part, we will discuss the economic importance of the Fed funds rate and Dr. Charles Plosser’s views on effectively communicating the monetary policy.
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