Enhancing Fed Credibility

“TOO MUCH OF A GOOD THING CAN BE WONDERFUL.”—MAE WEST

Yellen By Janet L. Yellen

Janet L. Yellen is President and Chief Executive Officer of the Federal Reserve Bank of San Francisco. Previously, she was professor of economics at the University of California at Berkeley, a member of the Board of Governors of the Federal Reserve System, Chair of the President’s Council of Economic Advisers, and on the faculties of Harvard University and the London School of Economics. She graduated summa cum laude from Brown University and received her Ph.D. in economics from Yale University.

The Fed’s credibility regarding control of inflation helps to anchor public expectations of price stability. This makes the Fed’s actions more predictable in any given set of circumstances and thus strengthens the monetary policy transmission mechanism and shortens policy lags. The importance of the Fed’s credibility can be illustrated by the consequences of its absence in the 1970s. This paper discusses the roots of the Fed’s current credibility: a systematic approach to controlling inflation, transparency of its policy decisions, and timely communication of the decisions and the considerations upon which they are based. The paper also discusses areas in which there is room for further improvement. It argues that the most important future step would be to adopt specific inflation targets. Such a step would not only enhance credibility, it would help to focus policy-making itself. While there are some risks to establishing specific numerical targets, these risks can be managed and are outweighed by the benefits of explicit targets.

This paper is based on the luncheon keynote speech to NABE’s Policy Conference on March 13, 2006.

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