Transcripts of the monetary policymaking body of the Federal Reserve from 2002–2008.

I guess by default I will start. First of all, I favor alternative B, both the language and the unchanged federal funds target. Let me make a couple of comments about market liquidity. First, liquidity is not reduced at all by deals. Deals simply transfer the funds from the buyers to the sellers, who then have to figure out what to do with all that cash. Deals are probably being driven at least in part by very narrow risk spreads. But my sense is that so far these spreads are consistent with actual losses in the markets. Obviously, if that situation continues, then risk spreads should remain low, and we should continue to have a very active amount of deal making. Some of the returns from the deals really feed into good productivity performance because part of the purpose of these deals is to take over companies that are not performing well and to eliminate marginally profitable or unprofitable operations and that is really good for productivity. To the extent that the deals are simply increasing leverage—sort of financial engineering—then that does not do anything for productivity. It does increase risk and vulnerability should the economy perform other than anticipated. We cannot really do anything about that situation except to avoid creating surprises ourselves; it is really, on the whole, beyond our control. Governor Kohn talked about standard errors, and I must say that, when it comes to standard errors, I am very much an indexer and not a market timer. [Laughter] It is easy to fool yourself just as in investment policy, but that is where I come out there.

On the issue of the inflation target—and I am glad that we are closing in on this topic—I honestly do not believe that we can credibly be satisfied with an inflation forecast for 2009, that far out, of 2 percent and at the same time continue to talk about a comfort zone of 1 to 2. That does not seem to me to be internally consistent because we cannot control inflation to 0.1 percentage point. So either we have to decide that our true target is something like 1½ plus or minus ½ as an issue for control errors and other considerations, or we need to start being explicit about a comfort zone of 1½ to 2½. I am worried about the latter approach because it runs the risk of raising market expectations and of unhinging expectations. Expectations have been very solidly held. If we get into a situation in which, through inevitable things that happen that we cannot control, the inflation rate were to run consistently at, let’s say for the sake of argument, 2½ instead of around 2, then those market expectations might not be so well entrenched at 2½ as a consequence of having willingly and openly or by default—by revealed preference, if you will—moved effectively to raise the comfort zone. I am very much a hardliner on this. I think that we ought to continue with a comfort zone of 1 to 2, and we ought to think about the inflation target as being 1½ plus or minus a half. Thank you.

Keyboard shortcuts

j previous speech k next speech