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Plosser on the benefits of systematic guidance for the base rate

Phalguni Soni

Determining the Fed’s monetary policy needs a systematic approach (Part 4 of 7)

(Continued from Part 3)

The benefits of systematic guidance for the base rate

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 the last part, we discussed Dr. Plosser’s views on rules-based or systematic approach to forward guidance. In this part, we will discuss his take on the benefits of a rules-based approach versus a discretionary approach to monetary policy communication.

“So what do I mean by a systematic approach to policy? Quite simply, I mean conducting policy in a more rule-like manner. The antithesis of such rule-like behavior, of course, is discretion; that is, policymaking conducted period by period with great latitude to take whatever actions seem best at the time,” said Dr. Plosser in his speech.

Charles Plosser on monetary policy transparency

Dr. Plosser explained that transparency in monetary policy is a relatively new phenomenon — the Fed began announcing monetary policy decisions taken at its Federal Open Market Committee Meetings (or FOMC) only since 1994. The reason why the Fed and central banks around the world are increasingly embracing transparency, is because monetary policy communication includes not only the central bank’s view on the current base rate, but also on its projected path in the future.

Rules-based monetary policy guidance can reduce uncertainty in financial markets

Market expectations play an important role in determining economic outcomes. Monetary policy guidance affects the future projections made by market participants. A credible and rules-based approach to monetary policy guidance can reduce uncertainty in financial markets and make guidance more effective.

According to Dr. Plosser, “The ability to behave systematically and to align the public’s expectations with that systematic behavior can allow the central bank to increase current economic activity, while simultaneously lowering inflation. But a credible commitment to honor past promises is an essential element of rule-like policy. Discretionary decision-making undermines such commitments.”

To know about how market expectations and rules-based guidance can impact economic activity and financial markets, affecting stocks like Ford (F) and ETFs like the iShares U.S. Home Construction ETF (ITB), the PowerShares Insured National Municipal Bond Portfolio (PZA), the iShares iBoxx $ Investment Grade Corporate Bond Fund (LQD), and the iShares 20+ Year Treasury Bond (TLT), move on to Part 5.

Continue to Part 5

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