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Fed official: Public deserves detailed policy road map

November 8, 2011 |  1:47 pm

KocherlakotaA top Federal Reserve official thinks the central bank should get very detailed about how it would change policy in the future, depending on what happens in the economy.

Narayana Kocherlakota, president of the Fed’s Minneapolis bank and a voting member of the Federal Open Market Committee, on Tuesday called for the Fed to provide a “public contingency plan” spelling out potential future moves.

In a speech in Sioux Falls, S.D., Kocherlakota said the idea of such a plan would be to “provide clear guidance on how [the Fed] will respond to a variety of relevant scenarios” -- for example, how much short-term interest rates would be raised if inflation were to rise above a certain level.

The Fed has been talking a lot more lately, internally and publicly, about how best to communicate its views on the economy and possible policy changes. That's one reason why  Chairman Ben S. Bernanke earlier this year agreed to hold periodic news conferences.

Some Fed officials, including Kocherlakota, want to push the central bank into laying out specific policy reactions to economic shifts.

From his speech:

For example, the Committee recently projected that in 2011, core inflation will be 1.9% and that it will fall back in 2012 and 2013 to around 1.7%. Suppose hypothetically that core inflation, and the outlook for core inflation, has risen to 3% by the end of 2013, while unemployment has fallen to between 8% and 8.5%. A public contingency plan would allow the public to know what the Committee intends to do in that eventuality.

Kocherlakota was one of three Fed officials who dissented at the central bank’s August and September meetings, when the majority of policymakers voted to offer more help to the economy. At the August meeting the Fed said it was likely to hold its benchmark short-term rate near zero for at least another two years.

Kocherlakota thought that was going overboard. He believes that laying out a specific plan of what the Fed would do, based on what actually happens in the economy, would allow businesses and consumers to make better decisions about spending, investing and hiring.

“I’ve heard from businesses that policy uncertainty is curbing their incentive to hire or invest,” Kocherlakota said. “Similarly, I’ve heard from consumers that policy uncertainty is curbing their incentive to spend. A public FOMC contingency plan can help reduce the level of policy uncertainty being created by the Fed.”

Other Fed officials, however, have raised concerns that such a plan could hamstring the central bank.

Kocherlakota doesn’t buy it:

No contingency plan can ever be definitive. Inevitably, the FOMC will learn things that it did not expect to learn, and events will occur that it did not expect to occur. And so there may be conditions that force the FOMC to deviate from a chosen plan. However, having a public plan, and couching its decisions against the backdrop of that plan, will enhance Federal Reserve transparency, credibility, accountability and consistency.

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-- Tom Petruno

Photo: Narayana Kocherlakota, president of the Federal Reserve Bank of Minneapolis. Credit: Federal Reserve

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