The president of the Philadelphia-Fed advocates an explicit inflation target
The Fed in Search of a Strategie for the Time after Greenspan

Anthony M. Santomero, President of the Federal Reserve Bank of Philadelphia, does not fear any trouble in the financial markets when Federal Reserve chairman Alan Greenspan leaves office at the beginning of 2006. "It is understandable that the markets ask 'what will happen' when a central banker of this stature retires", Santomero told the Handelsblatt.

HB BERLIN. "They will come to realize, however, that the FOMC has 19 members and that our decision-making process remains essentially the same." The FOMC (Federal Open Market Committee) is the decision-making committee for monetary policy in the Federal Reserve System (Fed). The president of the "Philly Fed" has voting rights on this committee.

Increasing concerns are flaring up in the markets over the direction of U.S. monetary policy in the post-Greenspan era. Since 1986 he has successfully steered the fortunes of the Fed primarily by his charisma. He understands monetary policy as crisis management. He has always rejected a monetary policy strategy in which a central bank commits itself publicly. In the run-up to his departure, the lack of such a strategy and the continuity that comes with it makes for uncertainty.

"Greenspan has not only raised his profession to an art. He has also institutionalized the process that leads to good decisions and consensus," explained Santomero. "The chairman will change. But everything else remains the same." For the president of the Philadelphia-Fed the last four years have proven how constructively the FOMC works together as a committee. Since the beginning of 2001 the committee has reduced the fed funds rate to its lowest level in 50 years. Now it is being raised again. The interest rate moves were accomplished with broad consensus and with practically no opposition, Santomero said. The Fed looks back over more than two decades of price stability.

For Santomero, who visited the American Academy in Berlin, the announcement of an inflation target would be the clearest signal that the FOMC will continue the legacy of the past. "If we tell the markets openly what target we are striving for and let ourselves be measured by this and in how far we stick to it, we increase the credibility we have acquired over more than 25 years. It would be a further logical step on the Fed's way to more transparency."

Within the FOMC the possibility of an inflation target is being discussed with controversy. At the meeting at the beginning of February the issue was deferred. Along with Santomero the proponents include Ben S. Bernanke, a member of the Fed Board of Governors, and Janet L. Yellen, president of the San Francisco-Fed. From the minutes of the meeting it is clear that some members maintain that an inflation target is incompatible with the dual mandate of the Fed. It is supposed to ensure simultaneously price stability and maximum employment. Santomero is open on the issue of whether the FOMC can succeed in reaching an understanding about an inflation target before the change in the head of the Fed. "I can only say we will discuss the details further. Anything else would be pure speculation." The timing is not crucial for the former professor. It is only important that the FOMC fully support the strategy, he said.

Santomero promotes a target band from one to three percent, measured by the 12-month moving average of the price index of personal consumption expenditure (PCE) - excluding food and energy prices. For the last decade this inflation rate in the USA has fluctuated between one and two percent. The PCE is broader than the consumer price index. Its weighting is continually updated. It corresponds to the actual consumption pattern. "Such a band would coordinate the decision making in the FOMC, would improve communication with the markets, and would strengthen the confidence of the public that prices would remain stable over the long run as well", declared Santomero."It allows monetary policy sufficient leeway to react to shocks and imbalances. There can be no talk of conflict with the dual mandate of the Fed: Price stability furthers growth and employment."

Santomero suggested that the markets cannot assume that they will be so clearly informed about the future course of monetary policy as they are now. Since August 2003 the Fed has expressly communicated its interest rate intentions and no longer communicated them just indirectly as in earlier periods. In the statement of the FOMC from August to December 2003 it says, "The accommodative policy can be maintained for a considerable period." Since May 2004 the committee has repeated, the tightening "can likely be achieved at a measured pace."

"It is neither customary nor necessary that the Fed or any other central bank make known its longer term course of action in its policy statement", said the 58-year-old. According to him the FOMC believes that the economy has entered a period of sustainable expansion and that monetary policy should react accordingly. "That has been communicated to the markets. However, it is not meant to be an exact plan of action for the Fed, even if the markets have been correct in this interpretation until now", Santomero explained. "Fundamentally, monetary policy actions will be dependent on the incoming data."

Santomero does not see evidence of a price bubble in the bond markets. "The bond market tries to ascertain how short-term interest rates will develop over the next 20 years", the central banker said. Thus, they are assuming continued low inflation. "I lean toward believing the markets. In any case, I would not bet against them at the present time."

Marietta Kurm-Engels
Marietta Kurm-Engels
Handelsblatt / Redakteurin
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