As the Chairmanship of the Federal Open Market Committee (FOMC) passed from Alan Greenspan to Ben S. Bernanke in February 2006, investors anticipated a philosophical shift within the FOMC. Given Chairman Bernanke’s academic groundings, many observers hoped that future FOMC monetary policy actions would become more science than art. Since then, investors and academics alike grew increasingly confident of a “rules-based” FOMC—that is, monetary policy formulated not in committee, but instead by mathematical model—as the final installment to achieving complete transparency in FOMC actions. Only thing is, a recent speech from FOMC Governor Frederic S. Mishkin, suggests this much awaited final phase may never come to pass.
The secrecy surrounding monetary policy decisions by the FOMC is legendary. For years, investors seeking the FOMC’s intended course for monetary policy found themselves participating in an effort akin to reading tea leaves. That is until February 1994. You see, in 1994 the FOMC began releasing statements to accompany changes in the inter-bank overnight lending rate, more commonly referred to as the federal funds rate. Though the days of reading tea leaves had arguably ended, the Greenspan FOMC remained less than enthusiastic about conducting a formulaic approach to monetary policy, citing the many imperfections in the economic data streams.
With Bernanke, hopes reignited. Surely, the days of reading tea leaves or between the lines would soon end.
Or so investors thought.
Speaking at a forum on applications and formulation of monetary policy, FOMC Governor Mishkin essentially threw cold water on the budding idea of complete transparency when he suggested in his speech, “Monetary policy has indeed become more of a science. There are, however, serious limitations to the science of monetary policy.” Put another way, as former vice chairman of the Federal Reserve Board Alan Blinder has emphasized, “Central banking in practice is as much art as science.”
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After reading Mishkin’s examination of the pros and cons of rule-based and formulaic monetary policy there is little doubt in my mind his conclusion is un-hedged and straightforward. Simply put, if I interpret his meaning correctly, economic activity is not a static event and as such, the use of static models serves little purpose. This is not to say he implies that the econometric and monetary models used by the FOMC are without merit. Rather the “art” comes in knowing which model to use at which time—if at all. In other words, I believe investors are safe to conclude that monetary policy is not about to be outsourced to a computer any time soon.
1 Mishkin, Frederic S., “Will Monetary Policy Become a Science?”
Finance and Economic Discussion Series, Divisions of Research, Statistics and Monetary Affairs, Federal Reserve Board, Washington, D.C., September 21, 2007, page 20.
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