Should the Fed Be More Reserved?

When you can't say what you mean, stop talking.

Remember how Ben Bernanke's Federal Reserve was supposed to be all about openness and transparency? Somehow he and his colleagues still gave the markets whiplash by talking about how monetary policy might change in the future. It's certainly useful to have some idea of what the Fed's officials are thinking. But if they're lousy at making their points clearly, what else can they do?

When Bernanke took over as chairman, he emphasized transparency as the keystone of his approach to policy. He took a professorial and explanatory approach in his appearances before Congress, in contrast to the deliberately nebulous pronouncements of Alan Greenspan. He also changed the Fed's disclosure process to share more of its data and publish the minutes of its meetings more quickly. And in January 2012, the Fed committed to holding inflation near 2 percent -- its first-ever numerical target, suggested by Bernanke at his nomination hearing eight years ago.

Never before has the public had such a direct view into the making of monetary policy, in the United States or anywhere else. What we saw hasn't always been pretty. The Fed's governors and regional bank presidents have had some healthy debates about economic trends and ways of dealing with the recent slump. But they've also missed worrying signals of crisis and recession, worried about inflation that never arrived, and changed their minds several times about the use of their monetary tools.

More recently, their frank approach to communication has caused disruption in global financial markets and the economy. On June 19, Bernanke gave a press conference in which he seemed to hint that the Fed would stop buying assets in financial markets, putting an end to its "credit easing" strategy, and markets everywhere tumbled. But within a week, other Fed officials were pouring cold water on the notion that the policy would change anytime soon, or at least before the economy appeared much stronger. It took weeks, however, before the genie was back in the bottle and the markets were calm.

The media has had a field day with all of this, of course, raising questions about the overall value of the new transparency. Confidence in the Fed, whose officials already suffer regular attacks from Republicans in Congress, may be eroding; seeing the inside of the sausage factory doesn't necessarily make the end product more appetizing. On the other hand, the public is now getting information about the economy sooner than it did before.

In fact, the true value of transparency may be in knowing a bit more about how the Fed governors do their job: what data they follow, what they think is important, what triggers would lead to what decisions. This information allows economists, investors, and anyone else to critique the Fed's thinking. If the governors are missing something, the public can try to let them know.

Yet there's still the problem of people misunderstanding the Fed, particularly when it talks about the future.

Bernanke's attempt to describe the coming direction of American monetary policy actually misled millions of people, making it just as bad, if not worse, than Greenspan's riddles. The day before his speech, the interest rate on the 10-year Treasury was 2.2 percent; a week later, it was 2.6 percent, even though the Fed's officials tried to reassure investors that they would continue to inject credit into the markets. There's less risk of this happening when the Fed discloses the minutes of its meetings or tries to explain past and current policy; in these cases, the connections between words and deeds are clearer.

If the Fed wants to telegraph its plans -- and recent evidence suggests it does, to avoid causing disruptions and volatility in the markets -- there are better ways. One possibility is to automate policy by setting plans of action for a series of circumstances -- saying that when X happens, the Fed will do Y. For example, Narayana Kocherlakota, president of the Minneapolis Fed, suggested last year that the Fed keep short-term interest rates low until the unemployment rate fell to 5.5 percent, unless inflation began to rise.

Another option is simply to eliminate opportunities to change policy. The Fed's Federal Open Market Committee, which makes decisions on interest rates, is required by law to meet four times a year. Lately, its practice has been to meet eight times a year, plus the occasional emergency meeting. What better way to signal that a policy will remain in place, barring anything urgent, than to cancel the committee's meetings for a few months?

A third alternative that could work in conjunction with (or instead of) either of the first two would be to attach some kind of consequences to a failure to carry out stated policy. In other words, a Fed chair could promise to resign if the Fed did not keep the target for short-term interest rates fixed for the next nine months, or did not adhere to a rule like the one Kocherlakota proposed. This threat might not be credible, though, if a resignation would disrupt markets even more than changing policy.

All of these mechanisms are designed to help the Fed commit itself to policy in the future. In each case, the policy needs to be specified in a way that's clear and verifiable; the commitment is no good if no one can tell if the Fed followed through. Bernanke is an expert economist who is undoubtedly well aware of how such mechanisms are structured. He has six more months to save the Fed from mistakes like the one he made.


Daniel Altman

The Nearly Foolproof Recipe to Make Poor Countries Richer

It's not what the World Bank's president is cooking up.

Could a "social movement" end poverty within a generation? That's what Jim Yong Kim, the president of the World Bank, said last week in Washington. He may be right, but he's also got the wrong kind of movement in mind.

Kim envisions a global movement where people from dozens of countries come together to fight poverty by making huge social investments and demanding progress on issues like corruption and climate change. But that's not the most direct way to help economies grow and raise the purchasing power of poor people.

Economic growth happens when the work force either expands or becomes more productive. The Kama Sutra suggests many ways to achieve the former, but there are only two ways to achieve the latter: give workers control of more physical capital, or give them better technology. In practice, this usually means moving workers into cities and adopting production techniques and product designs already established in other countries. The last ingredient is trade, which can bring more capital and ideas into the country.

This simple sequence of urbanization, industrialization, technology adoption, and exports is essentially the story of growth in East Asia and some other countries scattered around the world. It is an almost foolproof recipe for higher incomes, though of course it says nothing about the distribution of those incomes.

There is still plenty of scope to follow this recipe in poorer regions like sub-Saharan Africa. Compare the following three graphs, each of which compares the urban share of countries' populations to their per capita purchasing power, using data from the World Bank:

The first graph plots urbanization against incomes in East Asia and the Pacific in 2011, and the second does the same for sub-Saharan Africa. Clearly, both regions show a strong relationship between living in cities and buying power. Once people get off the farm, they can work in factories and service operations with greater specialization and economies of scale. It's also easier to reach people with essentials like energy and health care when they live close together.

Though the slopes of the relationships are similar in the two graphs, the purchasing power that corresponds to a given level of urbanization is consistently lower in sub-Saharan Africa. Even with urbanization, some factors are holding back incomes in the region.

There's not much mystery about what those factors are. With its borders imposed by foreign powers, sub-Saharan Africa suffers an apparently endless string of civil and regional conflicts. Global politics have also played a role, as countries in Africa have enjoyed free access to the world's biggest export market -- the United States -- only since 2000, and even then have faced hurdles to exports.

There are also many more landlocked countries in sub-Saharan Africa, making commerce more difficult. And then there is the matter of disease, which springs up more readily in tropical zones. Sub-Saharan Africa may be known for epidemics ranging from HIV to Ebola, but respiratory and intestinal diseases are just as prevalent.

East Asia had its own problems with public health and diseases including malaria, yaws, and flu. Dengue continues to affect the region, but the other diseases are steadily coming under control. East Asia also had its share of violence, but most of its countries have been fairly peaceful since the end of the Vietnam War. Moreover, those that once battled the United States got access to the American market much earlier than sub-Saharan Africa, thanks to post-conflict diplomacy.

That's where the third graph comes in. Winding the clock back 25 years, the best-fit line for East Asia in 1986 looks pretty similar to the one for 2011; it sits a bit lower, but still above the line for sub-Saharan Africa in 2011. This difference over time may just signify the accrual of a quarter-century worth of new technology; the overall environment for growth in East Asia hasn't changed very much.

Yet this is the key to sub-Saharan Africa's future. Its ability to grow can improve quickly if its countries can enhance the overall environment for that simple sequence of urbanization, industrialization, technology adoption, and exports. Right now, however, much of the time and money devoted to its "development" -- especially when foreigners have a say -- goes to things like raising crop yields, building bridges, and local programs to bolster health and education. These efforts can make a difference to people's lives, but they are not necessarily addressing the main factors holding down sub-Saharan Africa's best-fit line.

An alternative approach would pursue the recipe for growth more directly. For urbanization, people need title to their land (so that they can sell it or use it as collateral), freedom of movement inside their countries, and information about opportunities. To speed industrialization, countries can strengthen property rights (to ensure investors receive their returns), relax capital controls, and protect foreigners against expropriation and self-dealing by local partners. Faster adoption of technology arrives with the chance to import foreign goods and learn new ideas via global networks and media, as well as the opportunity to travel, study, and work abroad. Access to export markets is usually the culmination of years of diplomatic effort and regulatory grunt work. And ending conflict can help all of these steps at once.

These changes require more political will but also fewer resources than the multi-billion-dollar aid and investment programs that stretch across the globe. So perhaps Kim is right -- ending poverty does require a movement, but it's a movement of citizens in individual poor countries rather than a global movement propelled by big companies and non-governmental organizations. Only when citizens demand new policies that directly support growth will their countries be able to follow the recipe that has worked so well in other places.