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Construction and Monetary Policy: a View from the Sidelines

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Construction and Monetary Policy: a View from the Sidelines February 15, 1999 Federal Reserve Bank of Cleveland Construction and Monetary Policy: A View from the Sidelines by Sandra Pianalto The Federal Reserve’s popularity in unemployment that was 1½ percentage the business community is as high as it points higher than the national average. has been in the 15 years I’ve been in the On January 27, Sandra Pianalto, System, and perhaps as high as ever in For some reason, the business commu- First Vice President and Chief Oper- our 86-year history. I often hear someone nity is quick to give us the credit. Or per- ating Officer of the Federal Reserve say, “The Fed sure is doing a good job.” haps I’ve said that backwards. It is often Bank of Cleveland, spoke at the an- supposed that the Federal Reserve has nual forecast dinner held by the As Chief Operating Officer of the Fed- given borrowers, and your industry in Home Builders’ Association of eral Reserve Bank of Cleveland, I’m particular, access to relatively cheap Greater Akron. This Economic Com- tempted to interpret such a compliment credit, which has allowed our economy mentary is adapted from her remarks. as a statement about how efficient we to grow. If this is what “doing a good have become at clearing checks. And job” means regarding the performance indeed we have. But that isn’t what you of the Federal Reserve, then it’s a back- But here the analogy breaks down. We mean, is it? handed compliment at best. are not the arbiters of credit; the finan- cial system is. A better analogy, I think, Do you mean that the Fed is monitoring Judging the performance of monetary is that we are the makers of the monetary banks effectively, providing leadership policy is like judging the quality of NFL football. That thing you pass back and in electronic payments development, and officiating (an especially apt analogy forth between you. It’s a crucial part of working hard to ensure that all financial tonight, just four days before Super the business game to be sure, but a pas- institutions are Y2K compliant well Bowl XXXIII). Officiating is best when sive part. I’ve been at many football before New Year’s Eve? We are, you it is noticed least—when the game is games and not once have I heard some- know, but these accomplishments don’t what generates the thrills, not the rules one say, “Wow, what a great ball.” It usually get us noticed in the business of the game. If part of the crowd heaps goes unnoticed, and the players take for community. praise on officials, it’s generally in granted its constancy, its sameness, its response to a decisive call that helps predictable shape and size. Perhaps “doing a good job” means that create a wished-for outcome. And that, we are providing the world with one of of course, implies that there is another, I wonder if football manufacturers are its best known and most confidently used unhappy group to whom the officials’ ever tempted to make the ball a bit products, the dollar. And so we are. But I call seems less clearheaded. smaller to give the offense a boost. Or doubt this is what accounts for our recent maybe they’d like to let some air out of popularity—at least not directly. Indeed, for all the wonderful compli- the ball and turn things in favor of the ments we have received from the busi- defense. Thankfully, rules prevent the No, I am sure that satisfaction with the ness community recently, the Fed has ball from varying from contest to con- central bank reflects happiness over busi- gotten less-than-glorious reviews from test. The caretakers of the NFL want the ness conditions. You are prospering, and pensioners and others on fixed incomes game to be about the athletics on the have been, for one of the longest uninter- who believe that low interest rates have field, not about the whims of those who rupted periods in modern U.S. history. created a hardship for them. Like a foot- provide the footballs. This is precisely Here, in my hometown, we’ve seen the ball referee, I might be inclined to say why many of us in the Federal Reserve rate of joblessness fall to less than 4 per- that we call ’em as we see ’em. In what I System would like to see Congress give cent of the labor force. A remarkable will refer to as the “conventional view” the central bank a single objective—the level when you consider that this is ½ of of monetary policy, the Federal Reserve attainment of price stability—so that 1 percentage point under the very low is often presumed to be the judge of you can take for granted the predictabil- U.S. average—and in a region that, just what the “right” amount of credit in the ity and consistency of the dollar. a decade ago, had an average rate of economy should be. ISSN 0428-1276 ■ The Fed, Interest Rates, and (what economists call “real” interest of dollars in the marketplace, we do not Purchasing Power Uncertainty rates) are set in the marketplace through alter real values but only measured val- The invitation I received billed tonight’s the negotiations of investors who supply ues. We create the illusion of growth and event as an “annual forecast meeting.” capital to the credit market and the prosperity, not the real thing, and then And I clearly understand your expecta- entrepreneurs who use that capital to come to regret it. Once we learn that our tions for my remarks: The health of the fund business expansion. wealth has not grown in real terms, but construction industry is sensitive to the rather that the dollar has shrunk, we level and direction of interest rates; you The conventional view has popular ap- must reverse all the bad decisions that would like me, as a representative of the peal because people don’t always make were based on that erroneous measure- Federal Reserve, to tell you what those the necessary distinction between nomi- ment. Further, we must protect the dollar interest rates will be. On this score, I’m nal and real values. By altering the from further debasement. afraid I must disappoint you. Not be- amount of reserves, we alter the supply cause there’s a deep secret that I can’t of money, which is distinct from credit. Here the distinction between nominal disclose, but because of a popular mis- By changing the supply of money rela- and real interest rates becomes crucial. conception about what the Fed actually tive to its demand, we change the pur- Credit markets want to be rewarded for does and how it does it. chasing power of a dollar. That is, we providing entrepreneurs with credit. change all measurements based on dol- That is the real interest rate. But they I do not doubt that credit availability lars. In other words, we create money, also want to be paid back in dollars that may be the single most important factor not wealth; a dollar is only a measure- have the same purchasing power as the in the near-term outlook for your indus- ment of wealth. ones they lent out. So the interest rate try. But how, exactly, do we control the will also have an inflation premium in it, amount of credit in financial markets? Perhaps an example would be useful. making nominal rates somewhat higher The conventional view of monetary pol- Suppose you live in a 3,000-square-foot than real ones. Finally, because lenders icy explains the process something like house, but you want more space. One know that the value of the dollar can this: If the Federal Reserve believes the thing you could do is to build a larger change at the whim of monetary policy, economy is overheating (or, in econo- house. This takes resources: lumber, an added bit of risk must be priced into mists’ vernacular, “operating beyond its concrete, drywall, and the knowledge to the real interest rate, something financial potential”), then it drains reserves from put them together. If, after all this effort, analysts call the inflation risk premium. the banking system. This, in turn, drives you had added 1,300 more square feet of up interest rates, and the higher rates living space, you would be happier The only way the Federal Reserve can cool the economy off. On the other hand, because you would have made a real lower real interest rates predictably and if we think the economy needs a little gain in your standard of living. sustainably is by eliminating the threat perking up, then the conventional view of inflation from the contract between would have us do the opposite—add Alternatively, suppose the government borrowers and lenders. In short, an reserves to the banking system, push wanted to help you out a bit. While they accurate, steady dollar may be the most interest rates downward, and in so doing might not take on any of the burden of indispensable tool used in the construc- boost economic growth. building a new house, they could easily tion industry. change the number of square feet in your This conventional view of monetary pol- present home by redefining the foot. The ■ The Outlook icy has at least two major shortcomings. Bureau of Weights and Measures in What about tonight’s subject, the out- To begin with, its adherents would have Washington, D.C. could decide that from look for the economy? We all know that you believe that the economy is inher- now on, the U.S.
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