Abstract
This paper traces the evolution of US central bank transparency and provides new evidence bearing on the question of whether the Fed has become more transparent in recent years. Before Alan Greenspan, who eventually became a grudging advocate of transparency, Federal Reserve Board chairmen typically prized secrecy over transparency. Ben Bernanke's empirical research led him to conclude that transparency actually enhances the effectiveness of monetary policy. Our original empirical approach incorporates reaction functions in comparing how the FOMC responds to a set of macroeconomic stimuli vs. how the futures market responds to the same variables. The evidence suggests that the Fed was not very transparent in the early Greenspan years, but became progressively transparent through Greenspan's later period and into the early, pre-crisis, Bernanke era.
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Notes
Fallout from the Watergate debacle and adverse economic conditions prompted Congress to push for a more open Fed during Arthur Burns’ tenure. New legislation required twice-yearly appearances by Fed leaders before Congress to present and defend Federal Reserve actions in the context of legislated goals. But when Congress passed the Freedom of Information Act, Burns ceased publishing the edited transcript of FOMC deliberations (with a 5-year lag), ostensibly to avoid any embarrassment of Fed officials. See Greider 1987, pp. 54–55.
Hearing before the Committee on Banking, Housing, and Urban Affairs [2005], 109th Congress, 1st session, November 15, p. 18. Asked at the hearings if he would speak in understandable language, an apparent reference to Greenspan's “Fedspeak” anti-transparency approach, Bernanke replied “I will try to speak clearly on all occasions.”
Bernanke [2008, p.184] (on the basis of November 14, 2007 address).
Kohn testimony, Committee on Financial Services, US House of Representatives, July 9, 2009.
Bernanke [2009] testimony, Senate Banking Committee, December 3. He also opposed the disclosure of information that might identify which depository institutions were borrowing at the Fed's discount window. Testimony, February 24, 2010.
Bloomberg 2010. That December, Bernanke also permitted a rare television interview with a sitting Federal Reserve Board Chairman (“60 minutes”) and in Spring 2011 held the first press conference following a FOMC meeting. Board of Governors of the Federal Reserve System News and Events, December 5, 2010 and April 9, 2011.
Beyond December 2008, of course, the error drops to near 0 as the fed funds rate remains fixed below 0.25. That period is omitted from the graphs as it is hard to attribute those low errors to transparency.
The breakpoints used in determining the subsamples are based primarily on changes in the administration of the Federal Reserve. A break is included between the Greenspan and Bernanke periods in order to capture any differences in the conduct of monetary policy by Fed Chairman. Within the Greenspan era, there is a breakpoint of February 1994, when the Fed begins explicitly announcing changes in the federal funds rate target. Within the Bernanke period, there is a break in August 2007 to capture the very different behavior of the Federal Reserve in response to the financial crisis. Chow breakpoint tests for these dates are all significant at the 1 percent level.
The federal funds futures data were obtained from the Chicago Board of Trade where federal funds futures auctions have been conducted since October of 1988. From the settlement price of the contract for the last trading day of the month, we extracted the expected average effective federal funds futures rate for the contract month. We use 1-, 3-, and 6-months forward fed funds future forecasts at a monthly frequency (e.g., the fed funds futures observations on January 31 give us forecasts for February, April, and July). The effective federal funds rate data were downloaded from the online database FRED® run by the Federal Reserve Bank of St. Louis. Inflation and unemployment forecasts were obtained from the Money Market Services Survey, currently maintained and sold by Haver Analytics. Quarterly NAIRU data are from the Congressional Budget Office. Monthly data were generated using interpolation, which should be very accurate given the slow rate of change of NAIRU. FEDSTOCK is a measure of the return on stocks relative to the return on bonds. FEDSTOCK=i/(e/p), where i is the long-term bond yield, e is the rolling 5-year average of earnings on the S&P, and p is the S&P 500 index. A higher value means that bond yields are large relative to stock earnings yields; implying stocks are highly valued relative to bonds. The computations are based on data available on Robert Shiller's website. HSEPE is a price-earnings ratio for the housing market defined as the ratio between the median sales price of a house and shelter component of the CPI (see Leamer [2002]).
“FEDSTOCK” is based on the “Fed Model.” The “Fed Model” got its name when the documents accompanying Greenspan's July 1997 Humphrey–Hawkins report to Congress contained a comparison between price-earnings ratios and Treasury yields as a means of gauging stock market over or under valuation. In fact, the comparison had been discussed by Fed officials, as reflected in FOMC transcripts, as a measure of disequilibrium at least a decade before that time. The “Fed Model” has also attracted some academic attention. Burton Malkiel [2004] demonstrated its superiority over mean reversion models in predicting long-run returns. Other variables have been used to measure equity market disequilibria in Taylor Rule models such as the change in stock prices or the change in the price-earnings estimates [Dupor and Conley 2004, Hayford and Malliaris 2004]. We use FEDSTOCK because of its close ties to the Federal Reserve. See Huston and Spencer [2009].
A possible criticism is that the independent variables respond contemporaneously to the fed funds rate. In particular, we might expect the stock market and perhaps the housing market to be quick to incorporate policy changes. To allow for this possibility, equations (6) and (7) were estimated using SUR and three-stage least squares. (Three-stage least squares is similar to 2SLS but adapted for SUR. Thus, it uses instrumental variables to correct for independent variables that are correlated with the error term and allows for contemporaneous correlation of the residuals from the two equations.) There is some small variation in the coefficients, but all retain their sign and significance.
We do not test the constants (α1=α2) to allow for a risk premium in the futures market.
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Spencer, R., Huston, J. & Hsie, E. The Evolution of Federal Reserve Transparency Under Greenspan and Bernanke. Eastern Econ J 39, 530–546 (2013). https://doi.org/10.1057/eej.2012.31
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DOI: https://doi.org/10.1057/eej.2012.31