Clear communication at the Fed: The impossible dream?
The Wall Street Journal has a new article on the Fed and how it intends to try to improve its easy money communications policy.
Let me try to make this as simple as possible.
The Fed will never succeed in making its communications clearer or even understandable because its policy is inconsistent and in fact involves basic contradictions. Even if it confronts that, it will not be able to make its policy choice clear..
'Forward guidance' is the first oxymororn in the Fed's arsenal: The Fed has offered us several different kinds of' forward guidance'. It has said that it will keep interest rates low for an extended period of time. It has said it will keep interest rates low essentially at zero until a specific period of time. It then changed that point in the future to which it promised to keep interest rates that low. And, recently it has replaced this policy with something new called 'forward guidance' that offers a profile for the Fed funds rate - a very specific profile.
Now, here comes the 'Magic'
On one level the Fed calls this 'forward guidance' that is supposed to help us make decisions about the future because it has laid out this futuristic yellow brick road for us to follow.
The contradiction is that even this 'forward guidance' is of a conditional nature and not what it seems. The Fed is not pledging to keep interest rates on this path, it is simply saying that it's the Fed's most likely view but that if the economy turns out to be different than policymakers anticipate POLICY will be different too- but it downplays that potential fork in the road.
In other words the Fed's 'forward guidance' doesn't seem to be any different than the typical economist forecast which says well on one hand this could happen on on the other hand that could happen. The Fed wants us to focus on 'this' hand and on 'this hand' only.
But beyond that, anyone who has paid any attention to the Fed or to what I've written above, is aware that 'forward guidance' should come with a subscript: the letter "t." This is because the the Fed's 'forward guidance' is only the Fed's 'forward guidance' that exists at a particular period, t.. And as we can see (and have seen, in fact) the Fed already has changed the nature of its forward guidance several times in the past.
So since the Fed's 'forward guidance' that it's offering us now, admittedly is conditional, and since the Fed already has exhibited substantial changes in the way it's characterized its 'forward guidance' in the past, why should we consider 'forward guidance' a tool at all - that is other than a broken tool? And, how can the Fed possibly change its communications to make this oxymoron clearer – that is unless it were to give up on the idea of 'forward guidance' altogether?
When Mario Draghi tried to adopt forward guidance at the European Central Bank a day or so after he expressed his intention to keep interest rates low for an extended period of time using almost exactly the old language that the Fed had used, Jens Weidmann, head of the Bundesbank, said quite specifically that 'forward guidance' would not keep the ECB from raising rates if monetary policy rules and price stability required it.
So what good is it anyway? The ECB exchange cuts right to the quick of it; doesn't it?
There is nobody at the Fed issuing this kind of blunt clarification or countermanding statement to Fed Chairman Bernanke. But it should be quite clear that the Fed is trying to deal from the top of the deck and the bottom of the deck at the same time. And this is why its communication message goes astray.
There may be some academic framework in which 'forward guidance' has some application and in the end can work. I suppose if you and pose the idea that 'forward guidance' exists and has credibility you can move ahead to solve equations based upon its existence. But in the real world the Fed cannot really provide true 'forward guidance'. In the real world 'forward guidance' is necessarily conditional and once 'forward guidance' is conditional it ceases to exist or to be useful or evento be guidance (it might well be misguidance).
Moreover, once 'forward guidance' has been offered in the past and has changed it undermines the impact and the potential usefulness not to mention the outright lack of veracity in trying to use it EVER again.
Except to this Fed...
I think that the Fed has an intellectual model of 'forward guidance' that is inapplicable to the real world and it doesn't understand that. I think when we recognize the intrinsic pitfalls of the policy of 'forward guidance' outside of an academic framework we begin to understand why the Fed communicates its policy intention so badly.
Problems beyond forward guidance and its flawed yellow brick road
In addition to all that messiness, we have the other wishy-washy aspects of Fed policy that have to do with an unemployment rate threshold that is not a trigger and may not be meaningful whatsoever. And as the Chairman begins to wander off into that weird Wonderland of guidance that once again doesn't exist (telling us what may happen when/if unemployment goes below 6.5%) it's no wonder that people get confused. On one hand the Fed seems so eager to please to provide us with benchmarks but on the other hand it recognizes that it can't provide us with benchmarks unless it's sure that they are going to serve the stated purpose it wants to put them to. At that point the Fed confronts a dilemma.So it has given us meaningless numbers!
Therefore, every time the Fed tries to tell us something that's very specific it winds up having hedge it with caveats and conditional statements that have to be elaborated and clarified at a later date. This is why Fed communication strategy can never be successful. It's just not possible.
This all traces back to Ben Bernanke embracing the dual mandate with a two-pronged objective. Even Yogi Berra knows that when you come to the fork in the road, you should take it. Not Ben. He wants them both.
The Fed has long had this same policy mandate but under Paul Volcker and continuing under Alan Greenspan the Fed had argued that it pursued its goal of maximum sustainable growth best when it achieved price stability.In that it successfully had hammered the two tines of that fork into a single cutting edge. But Bernanke unbundled the strategy to reveal two separate prongs of short run objectives. He brought open conflict back to policy.
He opened a can of worms, worms that continue to crawl across the table at the FOMC each meeting. These worms are not trained nor controllable and they continue to be the basis for the Federal Reserve trying to give us guidance on policy that simultaneously tugs it in different directions.
To make matters worse the Fed seems to have its own separate judgment or conscience working in the background apart from its stated policy metrics. The Fed seems to be wary of the size of its balance sheet at long last and wants to address that even though its policy metrics do not conform to that desire
So right now even with the unemployment rate well above the Fed's threshold level of 6.5% (whatever the heck that means) and with inflation under-shooting its long run target (2%) and even decelerating, the Fed Chairman is trying to point everyone to the prospect - in fact, what he deems as the likelihood- of the Fed trimming back on its quantitative easing later in the year.
That seems to be 180 degreees wrong, doesn't it?
To justify this at the last meeting's press conference the Fed Chairman finally told us that the factors that govern quantitative easing are different from those that govern the Fed's ordinary policy, effectively trying to drive a wedge between the fact that the factors governing ordinary policy are calling for the Fed to ease further while the Fed is trying to guide us toward a policy that will see it easing by less using QE. (All this completely ignores the fact that QE was adopted to solve the Zero Bound issue and was viewed at first as an extension of the Fed funds policy. So why QE forces now move it in the opposite direction of the Fed funds rate's governing forces is no small trick)
Only Jim Bullard among FOMC members seems to be bothered by the fact that the Fed's inflation objective is calling for it to do something very different from what it's doing.
As you can see I think the main problem with Fed policy has nothing to do with economics and everything to do it logic. Any logician could look at this and understand the conflicts inherent in what the Fed is trying to do.
The Fed by this time has drunk too much of its own Kool Aide and cannot see how foolish its own policy really has become.
When I was a youngster I remember learning the meaning of the expression that 'you can't have your cake and eat it too'. I think it's an expression that the Fed needs to confront and come to an understanding about. Because, when it comes to 'forward guidance' the Fed very much wants to have its cake and eat it too. It wants that in many other aspects of policy as well as I hope I have made clear above.
At least I hope it is clearer than the Fed's communication policy. And I hope it clarifies the problems with the Fed's communications policy.