Poole: Fed should not try to substitute its judgments for the market’s on appropriate security prices
Speaking today at a luncheon in remembrance of economist Milton Friedman, St. Louis Federal Reserve President William Poole, (an FOMC member) emphasized the need for the Fed’s policy to be more predictable and transparent, in order to avoid market shocks and ensure stability. Poole repeated the previous remarks of Fed President Bernanke regarding the importance of well-anchored inflation expectations. “Central bank behavior to anchor expectations of low and stable inflation is the single most important aspect of policy predictability.” He also said the central bank should hold firm to policy, regardless of short-term consequences to unemployment and bond and stock markets.
With regards to the recent drops in the markets, Poole said, “The Fed doesn’t know, and market participants do not know either, the full implications of last week’s stock market declines and increases in risk spreads. Market reactions last week may be overdone, or perhaps not. We just do not know.” On the possibility of Fed action, Poole said “The Fed should respond to market upsets only when it has become clear that they threaten to undermine achievement of fundamental objectives of price stability and high employment, or when financial-market developments threaten market processes themselves. The Fed should not try to substitute its judgments for the market’s judgment on appropriate security prices.”
Poole was optimistic about inflation expectations, saying, “Expectations now quite well-anchored and policy adjustments are not themselves disturbances to the market.” He said the Fed continuously monitors changes in inflation expectations and that the economy functions differently when inflation expectations are well-anchored; when poorly anchored, interest rate control can be dangerous and destabilizing. He also said there need be little or no uncertainty about Fed behavior the day before an FOMC meeting. More predictable policy promotes efficient decisions in the private sector.
Poole also commented on the market’s ability to stabilize itself, saying, “the decline in long Treasury rates last week surely helped to stabilize markets relative to a situation in which those interest rates were held fixed by monetary policy. If Fed had been pegging long rates, the flight to quality last week would have required the Fed to take funds out of the market.” Poole said that would have been a destabilizing response to market fears concerning housing and the subprime mortgages market. “Most of these upsets stabilize on their own, but some do not. I’m not saying the Fed should ignore what happened last week- we need to understand what is happening.” He did say the Fed shouldn’t permit uncertainty over policy to add to existing uncertainty and that the Fed funds futures market will reflect the probable course of economic growth and inflation, and will adjust as the outlook becomes clearer. “The market is making judgment on security prices, stabilizing the economy without the Fed having to lead the way.”