EconSouth (First Quarter 2004)

Jack Guynn is president and chief executive officer of the Federal Reserve Bank of Atlanta  

Don’t Short
the Long Term


When discussing the economy, economists and policymakers sometimes distinguish the short term from the long term. This distinction can help in framing discussions about the economic outlook, but it also can help monetary policymakers describe their respective views of the U.S. economy.

Using policy to cushion short-term swings
I am among those who believe that monetary policy should be anchored in clear, long-term objectives. However, I also believe that monetary policy should be used to cushion short-term economic swings when needed. That’s how the Federal Reserve’s Federal Open Market Committee (FOMC) used its monetary policy tools in 2001 when the economy began to cycle down after the record-long economic expansion of the 1990s.

But there were some differences in this past economic cycle from others in recent decades. Chiefly, inflation was low, and consumers and businesses expected inflation to remain that way throughout the entire economic cycle. Thus, the Fed was able to ease policy aggressively through 13 separate actions that moved the fed funds rate target from 6.5 percent in late 2000 to 1 percent in early 2004 with no threat to the low inflation environment.

As a result of these moves, U.S. monetary policy has been very accommodative during the past few years. One indication is the real funds rate, which can be roughly estimated by subtracting the current rate of inflation from the nominal fed funds rate. This measure of the real funds rate has recently been at, or even below, zero. In other words, borrowing short-term money has been very cheap. If the economic expansion continues to build momentum and breadth in 2004, which is what I expect, I believe it will be appropriate at some point to bring policy back to a longer-run setting that is more consistent with noninflationary, sustainable growth. To me, that’s what central banking is all about.

Economic time versus calendar time
During the past decade, the U.S. economy has, without question, reaped the rewards of effective price stability, which the FOMC fought quite hard to achieve. Most measures of inflation expectations today clearly suggest that financial markets and decision makers expect the FOMC to do what it can and should do to maintain low inflation. As a monetary policymaker, I am pleased the FOMC has that kind of credibility with markets, businesses, and individuals.

At the risk of disappointing some folks who might wish to profit from advance hints about the exact timing of future monetary policy changes, I strongly believe that the timing of policy actions should not hinge on “calendar time” but rather “economic time.” What’s economic time, you may wonder? I define economic time as “real time”—that is, as changes occur—in comparison to calendar time, which is measured in days, months, quarters, or years.

The distinction between calendar and economic time is important because changes can occur in the economy at any time. Unexpected shocks, the accumulation of new anecdotal information, or routine shifts of data may require the FOMC to reinterpret economic conditions at any point, thus calling for a different policy stance than many might have forecast based on previous FOMC statements.

I believe it is critical for the FOMC to make changes in policy based on what we see happening just in front of us versus outcomes we expected in our forecasts and FOMC statements from six months ago. Don’t get me wrong: Forecasting is extremely important, but forecasts can change, sometimes considerably, on the basis of the accumulation of new data and anecdotal information.

Looking ahead
Given the forecasts we have at this time, I see little threat that inflation is poised to rise significantly. One reason I’m not expecting a quick turnaround in the inflation outlook is the considerable amount of so-called slack that is judged to exist in many product and service markets. And today we have to think in terms of worldwide capacity and slack. Slack means that there are no shortages of plants, equipment, or labor, and this unused capacity helps stabilize the price of output from these resources.

But what complicates the outlook for inflation is the great difficulty of measuring the actual amount of slack. As we’ve seen, this measure can change quickly as some excess capacity is determined to be economically obsolete and closed down or written off. But how quickly current slack will be absorbed, or taken out of the market, depends upon both the rate of growth of final demand and technological developments.

While I don’t see significant inflationary threats currently, it’s important for monetary policymakers always to keep in mind that conditions can change. Therefore, I think we must remain on the lookout for any inflationary pressures that may begin to surface because once inflation emerges it can be difficult to control.

Again, I want to stress my view that it’s the role and responsibility of monetary policymakers to make sure that we keep sight of the longer run. The Fed’s mandate is to use monetary policy to sustain long-term, noninflationary economic growth, which in turn serves the other policy goals of job creation and an improved standard of living.

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