A Look Back at the Consensus Statement.

• Author: Lacker, Jeffrey M.

The Federal Reserve has initiated a review of its monetary policy strategy, tools, and communications. The Fed's current monetary policy strategy is enshrined in a document titled "Statement on Longer-Run Goals and Monetary Policy Strategy" that was first approved by governors and Reserve Rank presidents in January 2012 and has been reaffirmed with minor changes at the beginning of every year since (Board of Governors 2019). During the internal deliberations that led up to adoption, Federal Open Market Committee (FOMC) participants commonly referred to the draft document as "the consensus statement." For convenience, and out of habit, I will continue to use that term. (1)

Congress established the Fed's monetary policy objectives in 1977 (Steelman 2011). Thirty-four years later, the FOMC's consensus statement translated that mandate into a publicly articulated strategic framework. It described the FOMC's approach to monetary policy in the terminology of flexible inflation targeting and formally announced the Committee's inflation target of 2 percent, as measured by the price index for personal consumption expenditures. It also explicitly declined to establish a numerical target for the unemployment rate.

Periodic review of the foundational framework and assumptions guiding strategic choices is a best practice for any sizable organization. The exigencies of meeting-to-meeting decisionmaking can divert attention from deeper questions that deserve attention over time. The Federal Reserve therefore is to be commended for launching this review.

The focus of the Fed's strategy review is on whether the effectiveness of the policy framework articulated in the consensus statement can be improved. This article reviews the consensus statement and the deliberations that led to its adoption. The Federal Reserve was late to the game compared to other central banks that had adopted transparent inflation targeting frameworks in the years since the Great Inflation of the 1970s (Bernanke et al. 1999). But the delay was not for lack of attention--serious discussions of inflation targeting began in the mid-1990s and resumed in the mid-2000s. Resistance stemmed from desires to preserve discretion and concerns that an inflation target would diminish commitment to the employment component of the Fed's mandate. To overcome the latter, an announced inflation target was framed as affirming and making transparent the strategy the FOMC was already pursuing--that is, as not signifying a change in the conduct of monetary policy. Work toward an explicit target was episodic and seemed to ebb and flow with tactical exigencies such as the perceived need for monetary stimulus. The final push that resulted in adoption of the consensus statement began in the run-up to the large-scale asset purchase program announced in November 2010 (QE2), when Bernanke advocated simultaneously adopting an inflation targeting framework in order to help stabilize inflation expectations and avoid the perception of a one-off "shock-and-awe action." It picked up further momentum in 2011 as the FOMC considered adopting forward guidance based on quantitative unemployment rate thresholds, which would have sent confusing signals in the absence of an explicit inflation goal. Both of these factors--the emphasis on continuity and the appearance of opportunism--may have diminished the effectiveness of the consensus statement at achieving its ultimate goal of improving transparency and helping to stabilize inflation expectations.

These historical insights are useful to bear in mind as the FOMC reviews their monetary policy framework. The dual mandate was handled awkwardly, and arguably confusingly, in the consensus statement; it disavows targeting "maximum employment," but highlights longer-run committee unemployment rate forecasts in a way that suggests low unemployment is a targeted variable. Attention to clarifying the Fed's view of the relationship between inflation and employment would be useful. Moreover, to avoid the appearance of opportunism, the bar should be high for adopting new strategic approaches, such as "makeup" strategies, that seem motivated by a desire to provide more short-term stimulus. Adopting such strategies would raise questions about what actions the Committee would take to elevate inflation as called for by makeup strategies, and why such actions could not be taken in any event to raise inflation closer to 2 percent if so desired.

The FOMC Discusses Adopting an Explicit Inflation Target

The FOMC's adoption of a formal strategy statement in January 2012 was the culmination of deliberations that stretched over decades. The idea of an explicit inflation target was broached as far back as 1983, (2) but interest picked up in the 1990s, coinciding with an international movement toward explicit inflation goals at central banks and interest by the new Republican majorities in Congress in giving the Fed a single price stability mandate (Bernanke et al. 1999; Transcript, January 31-February 1, 1995: 47). Fed Chairman Alan Greenspan organized a discussion for the January 1995 FOMC meeting that featured a debate on the merits of price stability between Janet Yellen, then a member of the Board of Governors, and Al Broaddus, president of the Federal Reserve Bank of Richmond (Transcript, January 31-February 1, 1995: 38-59). The committee was "split down the middle," according to Greenspan's characterization, and unable to adopt a common view (Transcript, January 31-February 1, 1995: 57)

A year and a half later, at the July 1996 meeting, the Committee again took up the issue, again prompted by the prospect of Greenspan being asked by Congress about potential legislation altering the Fed's mandate (Transcript, July 2-3, 1996: 41-68). This time, Broaddus and Yellen were able to agree that the Committee should "hold the line" and not let inflation rise above the then-current rate of 3 percent and should work over time to bring the inflation rate down to 2 percent. (3) Yellen argued that there was a permanent trade-off between inflation and employment due to downward nominal wage rigidities and that the costs of reducing inflation below 2 percent exceeded the benefits. The result was a broad "working consensus" to move the measured inflation rate down to 2 percent. Chairman Greenspan acknowledged the consensus but warned meeting participants against revealing the Committee objective to the public. (4)

The next full-fledged discussion of an inflation target was nine years later, at the February 2005 FOMC meeting (Transcript, February 1-2, 2005: 6-63). (5) Interestingly, eight participants voiced support for stating the price stability goal as a target range for inflation and just three preferred a point target. Despite wide support for an announced target, Greenspan cited likely political fallout, doubts about the benefits, and the potential to limit discretion as adverse consequences. Action was deferred with the suggestion that the Committee discuss how it would respond to various scenarios that might arise.

The organized discussions of inflation targeting under Greenspan were prompted by congressional interest in legislation that would provide the Fed with a price stability mandate replacing the 1977 legislation. Greenspan did not encourage such discussions apart from instances in which he felt the need to provide a Committee view in response to questions from Congress.

A "Modest Bit of Additional Transparency"

When Ben Bernanke was nominated as Federal Reserve Chairman in late 2005, he was already on record in favor of inflation targeting (Bernanke and Mishkin 1997; Bernanke et al. 1999; Bernanke, Mishkin, and Posen 2000; Bernanke 2003, 2004). The topic naturally arose at his nomination hearing, and Bernanke emphasized continuity with existing Fed practice:

I view the explicit statement of a long-run inflation objective as fully consistent with the Federal Reserve's current policy approach, including its appropriate emphasis on the role of judgment and flexibility in policymaking. Most important, this step would in no way reduce the importance of maximum employment as a policy goal [Bernanke 2005].

He went on to promise to go slow and check with Congress before taking action:

In any case, I assure this Committee that, if I am confirmed, I will take no precipitate steps in the direction of quantifying the definition of long-run price stability. This matter requires further study at the Federal Reserve as well as extensive discussion and consultation. I would propose further action only if a consensus can be developed that taking such a step would further enhance the ability of the FOMC to satisfy its dual mandate of achieving both stable prices and maximum sustainable employment [Bernanke 2005].

Under questioning, he pushed back repeatedly against the notion that adopting an inflation target would alter the Fed's mandate and require an act of Congress, as had been argued by Federal Reserve Governor Edward Gramlich in a January 2000 speech (Gramlich 2000). Bernanke called announcing an inflation target a "modest bit of additional transparency" (U. S. Senate, Committee on Banking, Housing, and Urban Affairs 2005: 20). Senator Paul Sarbanes (D-Md.), in particular, questioned whether an announced numerical inflation goal would not draw attention away from the dual mandate and stated that he did not think it was fully consistent with the Fed's then-current policy approach.

Bernanke's emphasis on continuity was clearly aimed at reassuring Democrats that announcing a numerical target for inflation would not diminish the Fed's emphasis on the employment side of the dual mandate. And his promise of extensive discussion and consultation implied that he would give key members of Congress a chance to weigh in. (6) His characterization of an inflation target as a "modest bit of additional transparency" seemed to conflict with the 1999 book he coauthored advocating...