Beliefs have a real impact
on the market, according to Anthony Santomero, President of the
Federal Reserve Bank of Philadelphia. What consumers and businesses
believe about the economy affects such empirical phenomena as rates
of production and employment as well as the accumulation of personal
and national wealth.
“Belief” is represented in economic
discourse by the ever present notion of “economic expectations,”
a concept at the heart of every economic decision made. Individual
expectations (such as whether consumers spend or save, how students
spend money, the ways in which employees prepare for retirement)
and business expectations (e.g., how future gains are projected,
the manner in which capital budgeting is planned, the way in which
management sees a firm’s value proposition, views on future
currency values and exchange rates) play an integral role in determining
larger market patterns.
Economic expectations also figure in policy-making.
For example, it has been argued in the current debate over tax cuts
that proposing long-term cuts may best promote spending because
consumers believe those cuts will be long term. Transitory changes
aimed at short-term economic response, on the other hand, may be
more effective in the case of stimulating equipment purchase through
related tax breaks that businesses believe to be only temporary.
The operations of the Federal Reserve Bank are
crucial to maintaining the stability of the public’s economic
expectations. Its central mandate, established by a Congressional
Act of 1913, is to foster the conditions for maximum sustainable
economic growth. Two critical factors in facilitating this growth
are keeping inflation at a minimum through price stability and offsetting
shifts in demand that defer the economy’s potential performance.
It is
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important that the
Fed establish long-term credibility in these functions in order
to maximize economic expectations that are conducive to its over-arching
goal of national economic growth.
Santomero compared the Fed’s poor performance
in the 70s—when it failed to maintain price stability in the
face of an economic downturn—to the recent success of its
aggressive counter-cyclical policy, which promoted spending into
the downturn and dampened the breadth and depth of this past recession.
As a discipline, economics has long studied expectations:
how they are formed, how they change, their speed of adjustment,
and correlations between beliefs and spending-investment patterns.
The methodology of these studies includes surveys, extrapolation
from past data, and economic modeling—calibrated to the past,
but projected into the future.
There is increasing awareness within the field—through
research and practice—that policy-makers can assist the market
through transparency in public discourse. In the case of the Fed,
providing explanations behind decision-making and strategic assessments
of the situations in which decisions are made enhances public confidence
in the Fed’s ability to achieve its goal of long-term economic
stability. As such, the Fed’s practices of inflation-targeting
are evolving from implicit to explicit in order to increase the
efficacy of its policy.
Outlook and expectations are at the core of economics
and are a self-fulfilling prophecy. Confidence leads to spending,
which leads to production, which leads to jobs, and, ultimately,
to economic growth. If national monetary policy hinges on confidence
in the Fed to maintain price stability, then the Fed must demonstrate
like stability in pursuing its objectives and communicating them
to the public. Santomero concluded by emphasizing the centrality
of action: doing that which creates credibility reinforces it. The
Fed seeks to maintain this exemplarity in fulfilling its mandate
of achieving sustained economic growth.
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