Congress established the Fed’s monetary policy objectives in 1977 (Steelman 2011). Thirty‐four years later, the FOMC’s consensus statement translated that mandate into a publicly articulated strategic framework. It described the FOMC’s approach to monetary policy in the terminology of flexible inflation targeting and formally announced the Committee’s inflation target of 2 percent, as measured by the price index for personal consumption expenditures. It also explicitly declined to establish a numerical target for the unemployment rate.
Periodic review of the foundational framework and assumptions guiding strategic choices is a best practice for any sizable organization. The exigencies of meeting‐to‐meeting decisionmaking can divert attention from deeper questions that deserve attention over time. The Federal Reserve therefore is to be commended for launching this review.
The focus of the Fed’s strategy review is on whether the effectiveness of the policy framework articulated in the consensus statement can be improved. This article reviews the consensus statement and the deliberations that led to its adoption. The Federal Reserve was late to the game compared to other central banks that had adopted transparent inflation targeting frameworks in the years since the Great Inflation of the 1970s (Bernanke et al. 1999). But the delay was not for lack of attention—serious discussions of inflation targeting began in the mid‐1990s and resumed in the mid‐2000s. Resistance stemmed from desires to preserve discretion and concerns that an inflation target would diminish commitment to the employment component of the Fed’s mandate. To overcome the latter, an announced inflation target was framed as affirming and making transparent the strategy the FOMC was already pursuing—that is, as not signifying a change in the conduct of monetary policy. Work toward an explicit target was episodic and seemed to ebb and flow with tactical exigencies such as the perceived need for monetary stimulus. The final push that resulted in adoption of the consensus statement began in the run‐up to the large‐scale asset purchase program announced in November 2010 (QE2), when Bernanke advocated simultaneously adopting an inflation targeting framework in order to help stabilize inflation expectations and avoid the perception of a one‐off “shock‐and‐awe action.” It picked up further momentum in 2011 as the FOMC considered adopting forward guidance based on quantitative unemployment rate thresholds, which would have sent confusing signals in the absence of an explicit inflation goal. Both of these factors—the emphasis on continuity and the appearance of opportunism—may have diminished the effectiveness of the consensus statement at achieving its ultimate goal of improving transparency and helping to stabilize inflation expectations.
These historical insights are useful to bear in mind as the FOMC reviews their monetary policy framework. The dual mandate was handled awkwardly, and arguably confusingly, in the consensus statement; it disavows targeting “maximum employment,” but highlights longer‐run committee unemployment rate forecasts in a way that suggests low unemployment is a targeted variable. Attention to clarifying the Fed’s view of the relationship between inflation and employment would be useful. Moreover, to avoid the appearance of opportunism, the bar should be high for adopting new strategic approaches, such as “makeup” strategies, that seem motivated by a desire to provide more short‐term stimulus. Adopting such strategies would raise questions about what actions the Committee would take to elevate inflation as called for by makeup strategies, and why such actions could not be taken in any event to raise inflation closer to 2 percent if so desired.