Michael T. Lewis, president of Free Market Inc, sent me an article he wrote for the Wall Street Journal a few years back in which he anticipated a theme I have fallen into over the past several days:
The Federal Open Market Committee (FOMC) has had only three minor dissents -- all for slightly greater easing -- since December, 2001 and none in the past 11 months. Even in public speeches, traditionally a less confrontational way to float ideas, these officials have been marching in lockstep. For all practical purposes, the FOMC has become the GOMC (the Greenspan Open Market Committee).
The recent silence is particularly deafening amid an unprecedented monetary policy. The federal-funds rate continues at a 40-year low, a situation that Mr. Greenspan has indicated will likely change only gradually.
The piece is dated June 22 2004, about a week before the Committee would begin to move the federal funds rate target off the one-percent mark, where it had stood for a year. Mr. Lewis goes on to offer an intriguing hypothesis: The Committee's effort to enhance the transparency of its policy decisions may actually have contributed to greater group think:
If the FOMC members have reason enough to entertain alternative views, this single-minded conformity must be caused by the institution itself. Mr. Greenspan has implemented sweeping changes in Fed procedures over the past 17 years that have changed the relationship between the chairman and the other decision-makers and between the FOMC and the financial markets...
Using this heightened transparency, Mr. Greenspan has placed greater emphasis on "communicating" with the markets; i.e., trying to manipulate long rates. For his strategy to have any hope of success, a single unambiguous Fed voice is critical....
Mr. Greenspan's communication strategy has had some short-lived successes: he was pleased by the plunge in long rates in spring, 2003, but bond yields quickly rebounded. Ultimately, the markets, being rational, respond to actions, not Fed rhetoric, no matter how unanimous. In exchange for these fleeting benefits, the chairman is sacrificing candid debate that could well foster better long-run monetary policy.
That challenge seems particularly important in light of the announcement that at its August meeting, the FOMC was begin "discussions of communications issues." I do, however, think it is useful to consider whether FOMC behavior since 2001 was a result of extraordinary economic conditions or extraordinary reactions to those conditions.
I think it was the former. Below is a picture I've shown before. It compares actual federal funds rate decisions (through the first quarter of this year) with those of an estimated "Taylor rule", which assumes that the FOMC responds gradually to deviations of GDP from potential (as measured by Congressional Budget Office "output gaps") and deviations of inflation from an implicit target:
If you can detect a substantial change in behavior from that record, you are doing better than I. I've argued in the past that what the communications efforts of Mr. Greenspan and the FOMC did accomplish was a better understanding by the public of how monetary policy responds to the economic environment. That, I think, is the real story, and I'm sticking to it.