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The Globe and Mail

What the Fed can learn from Canada’s number crunching

Charles L. Evans, president of the Federal Reserve Bank of Chicago and a member of the Federal Open Market Committee, is photographed during a Globe and Mail editorial board meeting on Nov. 27 2012.

Fred Lum/The Globe and Mail

Federal Reserve Bank of Chicago boss Charles Evans looks determined to sway the Federal Reserve Board's powerful monetary-policy committee toward using specific economic-indicator levels to help define the Fed's next interest rate move. Yet even the Federal Reserve system's biggest champion of these so-called "numerical thresholds" sees them as only a temporary tool to be used in unusual times (such as those we have now); he doesn't favour them as the basis for a permanent framework for defining interest-rate policy at the U.S. central bank.

Maybe he should. After all, the country he is visiting this week – Canada – has enjoyed the benefits of numerical-threshold policy framework for more than two decades.

Mr. Evans, speaking with The Globe and Mail's editorial board Tuesday in advance of a speech to a C.D. Howe Institute dinner in Toronto, repeated his past calls for the central bank's Federal Open Market Committee (FOMC) – of which he is an alternate member – to further define its dual-mandate approach to rate policy (employment maximization and price stability) by specifying numerical levels of inflation and unemployment at which the FOMC would consider raising its benchmark federal funds rate from its current near-zero level. The numbers he proposes are 6.5 per cent unemployment (the current rate is 7.9 per cent) and 2.5 per cent inflation (it's currently 2.2 per cent).

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"It's an appropriate approach to clarifying our forward guidance during very difficult times," he told The Globe and Mail's editorial board. "I think clarity is what would really be helpful."

Indeed it would. The Fed's notoriously cryptic use of language has long made its FOMC monetary-policy statements look less like transparent guidance than indecipherable code. Throughout the financial crisis and recovery, the Fed has been frustrated by the ultimate ineffectiveness of its monetary measures to fully take hold in the financial markets and restore financial conditions to where the Fed would like them; the opaqueness of the Fed's plans certainly hasn't helped.

The fact that the Fed this year clearly identified 2 per cent as its long-run inflation goal, and specifically linked its future policy moves to improvement in employment and price stability, is already a big step. And the financial markets have been receptive to this more detailed "conditional guidance" – perhaps emboldening the Fed to go further. Some key members of the FOMC like the idea of numerical thresholds, and it looks certain they will be explored further at the next FOMC meeting – though Mr. Evans declined to speculate how much support numerical thresholds have across the committee as a whole. (He noted that even the increased level of guidance the Fed has delivered recently came at a price, with several members of the committee expressing their dissent.)

Still, he doesn't see numerical thresholds as any more than a temporary tool for the Fed to better communicate its thinking regarding eventually raising rates from their current bottom.

"Once you're withdrawing from zero, you need to somehow describe your entire response path. Thresholds aren't going to do it," he said. "At some point, we have to describe what we're trying to do … we'll need different language."

But why not? The Bank of Canada has found that a single, clearly defined numerical threshold – its inflation band of 1 to 3 per cent, with a target at the 2-per-cent midpoint – has served as a simple, easy-to-understand, efficient and effective framework guiding the country's monetary policy since 1991. It instantly defines the Canadian central bank's thinking surrounding interest rates, instantly communicates a clear message to the markets. The numerical target, by itself, is a tremendous manager of market expectations. And, Canada's performance through the recession and financial crisis showed, it works.

A more precise indication of what the Fed is doing, why it is doing it and under what conditions it will do it couldn't hurt, and most certainly could help remove considerable guesswork from an uncertain market. Clarity fuels stability and confidence – something both the Fed and the markets can get behind.

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