Central Banks have not been Transparent. They have been Confusing

Jeff Frankel has the perfect punch line

Both the Fed and the Bank of England are accordingly now subject to much criticism for having delivered forward guidance that they were subsequently unable to stick to.   Some of these attacks are unfair.  No one should want the central bank to slavishly follow statements made in the past if circumstances have changed in an unexpected way.   Any fair critic must acknowledge that the ubiquitous demand for transparency with respect to the central bank’s plans (phrased simply) inevitably conflicts with the reality that the future is unpredictable, in particular with respect to such developments as unexpected fluctuations in the labor force participation rate.   Aware of the uncertainty, the monetary authorities have always hedged their foreign guidance:  nobody is now violating a past promise. Are the critics then being entirely unfair?

Not entirely.  There was another way.  A year or two ago, many of us were suggesting that the monetary authorities could announce a target or threshold for Nominal GDP, instead of for inflation, real income, unemployment, or other alternatives.    Some of us explicitly warned that a threshold phrased in terms of the unemployment rate would be vulnerable to extraneous fluctuations such as workers exiting the work force, and argued that a nominal GDP threshold would be more robust with respect to such unforecastable developments.

Just over a year ago, for example, I wrote in favor of “a commitment to keep monetary policy easy so long as nominal GDP falls short of the target.  It would thus serve a purpose similar to the Fed’s December 12, 2012, announcement that it would keep interest rates low so long as the unemployment rate remains above 6.5% – but it would not suffer the imperfections of the unemployment number (particularly its inverse relationship with the labor force participation rate…).”  [Central Banks Can Phase in Nominal GDP Targets without Losing the Inflation Anchor blog, December 25th, 2012.]

This is yet another instance of a long-standing point: if central banks are to focus attention on a single variable, the choice of Nominal GDP  is more robust than the leading alternatives. A target or threshold is a far more useful way of communicating plans if one is unlikely to have to violate it or explain it away later.

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