So, in a rapidly changing environment, the Taylor Rule and other similar prescriptive rules will wind up being “behind the curve.” For example, in the fall of 2008, Taylor Rule prescriptions were well above the level of rates that was appropriate given the sharp and persistent deterioration in the economic outlook and the sharp tightening in financial conditions that occurred during that period. Of course, many economists at that time recognized that such prescriptions would have been inappropriate and suggested various ad hoc modifications to the prescriptions – in fact, John himself suggested that modifications to his rule were appropriate at that time. 2 Nonetheless, there was no consensus about the “right” modification to the rules at that time, in part, because the circumstances were unprecedented and the outlook so uncertain. If the FOMC had been required to justify to Congress deviations from a reference rule at that time, I believe that this would have slowed down how we responded to the crisis and would have resulted in a monetary policy that was not sufficiently accommodative. The consequence could have been a longer financial crisis and a deeper recession. Second, the Taylor Rule, as typically used, assumes that a 2 percent real short-term interest rate is consistent with a neutral monetary policy. However, a large literature concludes that the equilibrium real short-term rate is very unlikely to be constant, with its value affected by many factors, including the pace of technological change, fiscal policy and the evolution of financial conditions.
Our first press conference was conducted in November 1974, shortly after the collapse of the BrettonWoods fixed exchange rate regime. Moreover, from 1975 onwards we published yearly goals for the growth of monetary aggregates in order to guide market expectations of interest rates and inflation. With the introduction of our new monetary policy concept six years ago, we took three specific measures in order to further enhance our transparency: •  First, we have defined consumer price inflation of less than 2% as our quantitative goal for price stability. This step has enhanced the predictability of our monetary policy because market participants know exactly what we want to achieve. They can expect monetary policy to be tightened if we believe that inflation could exceed 2%. •  As a second step, we now regularly publish a medium-term inflation forecast. This forecast helps market participants to predict future monetary policy because they not only know our goal for inflation, but also how we judge future inflationary pressures. •  Our third step towards more transparency has been to explicitly communicate our operational target. We announce our target as a 1% band on short-term interest rates, that is, on the three-month Libor. We thus regularly offer market participants a quantitative indicator of changes in our monetary policy stance. Our experience with the systematic communication of our monetary policy during the past six years has been very positive.