The Fed Chair’s Challenge: Be Clear, but Not Too Certain
The Federal Reserve chair, Jerome Powell, has declared war on inflation, and on Friday he was specific about his battlefield tactics. “July’s increase in the target range was the second 75-basis-point increase in as many meetings, and I said then that another unusually large increase could be appropriate at our next meeting,” Powell said at an economic symposium in Jackson Hole, Wyo. (Here’s the full text of his remarks.)
“At some point, as the stance of monetary policy tightens further,” Powell said, “it likely will become appropriate to slow the pace of increases.” Not yet, though, he seemed to say.
This degree of specificity would have seemed odd to Fed chairs of the past. The Federal Reserve used to be more secretive than a conclave of cardinals. Not only did its Federal Open Market Committee keep mum about its plans for interest rates, it didn’t even announce interest rate decisions it had already made until 90 days afterward. “I believe that release within a few hours or a few days after each meeting would seriously hinder the Federal Reserve in carrying out its policies,” Chairman Arthur Burns wrote to Congress in 1972.
In the late 1970s and the 1980s, by the time Paul Volcker and Alan Greenspan were chairing the Fed, it had become somewhat more transparent. But only somewhat. To figure out if the Fed was going to raise rates, Fed watchers would look at Greenspan’s briefcase when he headed into a meeting. The theory went that the briefcase would be thicker when he was toting evidence to support a rate hike.
Greenspan relished his reputation as a mystery-shrouded oracle. “I would engage in some form of syntax destruction which sounded as though I were answering the question but, in fact, had not,” he bragged in retirement to “60 Minutes.”
So those were the bad old days, right? Aren’t things so much better now that Powell’s (many) speeches, testimonies and news conferences are as clear as the pure mountain air of Wyoming?
Not everyone thinks so. Transparency is nice, but making the right decisions is even nicer. It’s clear now that the Fed erred by keeping interest rates too low for too long, allowing inflation to get excessively high. (I admit that I also underestimated how much inflation was in the pipeline last year.)
Kevin Warsh, who was a Fed governor from 2006 to 2011, told me that before joining the board he sought advice from Volcker, who famously slayed inflation in the early 1980s. In an email, Warsh wrote that Volcker told him, “First, get interest rates about right. Second, which is at least as important, be sure you look like you know what you are doing.”
Warsh, now a visiting fellow at the Hoover Institution, argues that Powell and other Fed officials are putting themselves in a straitjacket by issuing detailed and frequent “forward guidance.” Under forward guidance, Fed policymakers tell the markets and the public how they foresee the economy and monetary policy evolving in the coming months and years. Unfortunately, their predications can be — and have been — very wrong recently. Forward guidance “has proven to constrain their freedom and damage their credibility,” Warsh wrote.
I asked Ben Bernanke what he thought of the argument for limiting transparency and specifically forward guidance. Bernanke succeeded Greenspan, serving as Fed chairman from 2006 to 2014, and was a strong advocate of greater transparency and forward guidance. He wrote a book that was published this year, titled “21st Century Monetary Policy: The Federal Reserve From the Great Inflation to Covid-19.”
Bernanke said that transparency about the central bank’s outlook and policy approach is essential for accountability, but “whether that transparency should include explicit guidance about future policy actions depends on the context.”
This is where we get into Greek mythology. In monetary theory, Delphic guidance by a central bank (named after the Oracle of Delphi) is a simple prediction of what the economy and the bank itself will do. Odyssean guidance is stronger, a commitment to act a certain way no matter what the future holds. “Like Odysseus bound to the mast of his ship, a monetary policymaker must forswear the siren call of the moment and stick to plans laid in the past,” as Jeffrey Campbell, an economics professor at Notre Dame, explained the term while working at the Federal Reserve Bank of Chicago in 2013.
Odyssean guidance is useful in an emergency such as the global financial crisis. The economy and markets rebounded then when people were assured that the Fed would resist the siren call to snatch away their life support at the first sign of improvement. “We pledged to tie our own hands behind our backs in exigent circumstances,” Warsh noted. “This sent a powerful message at a time of great consequence — we’d do whatever it takes to get the country out of the mess.”
What’s not so good, Warsh added, is “talking incessantly about your next move as standard operating procedure.”
Some of the Fed’s critics say it went too far in the fall and winter of 2020 by issuing forward guidance that it would not lift its key interest rate off the floor of zero to a quarter percent until the economy was at “maximum employment,” a poorly understood standard. That forward guidance went well beyond what Fed policymakers had agreed upon earlier that year when they adopted a monetary policy called flexible average inflation targeting. And the statement, couched as an expectation, made it harder for the Fed to pivot in response to signs of incipient inflation.
“Delphic guidance can be a useful way to clarify the Fed’s outlook and policy thinking for the public,” Bernanke wrote in a follow-up email. “The risks of Delphic guidance are that the forecast proves wrong or that the market mistakes it for Odyssean guidance, that is, as a commitment rather than a forecast that can change when new data come in.”
The “dot plot” is a somewhat controversial example of the Fed’s forward guidance. On a plot of interest rates by year, the dots represent what members of the Federal Open Market Committee predict (Delphically) where the midpoint of the federal funds rate target range will be under what they consider “appropriate monetary policy.”
Powell has harrumphed when reporters have brought up the dot plot at Fed press conferences, explaining that it’s not a policy statement and carries no official weight.
“The dot plot is controversial,” Bernanke wrote. “Personally I find it a useful summary of current F.O.M.C. views. But it’s wrong to take it as a commitment rather than a forecast. In that respect some people find it confusing.”
Reading between the lines, I wouldn’t be surprised to see the dot plot disappear from Fed communications in the next year or so.
Getting forward guidance right is devilishly hard. In recent weeks, for instance, Powell and other policymakers have taken a hawkish line in public, trying to steer the markets away from the impression that the bank is nearly done with interest rate increases. On the other hand, they can’t be too firm about that, because maybe the economy will crack and they really will need to stop cranking rates higher.
“Powell certainly understands the difficulties of forecasting the economy,” Bernanke wrote. “In his first Jackson Hole speech,” which was in 2018, “he spoke eloquently about how models can break down, implying that the future is uncertain and guidance is therefore necessarily subject to revision.”
That’s good practice for a central banker. Be as clear as the situation calls for, but no clearer.
The Readers Write
I was struck by the emphasis on efficiency in your Aug. 19 newsletter about the economist Elizabeth Popp Berman. Efficiency can distort decisions in profound and deleterious ways. Russell Ackoff observed that a better measurement of policy and procedure is effectiveness. He said if one is not doing the right thing, doing it more efficiently means “doing the wrong thing wronger.” Although he was concerned with organizational development, I think the concept applies to economics as well. Hence the need to evaluate economic policy in a broader way for its effect on actual people.
Apple Valley, Minn.
Quote of the Day
“Gambling and gamboling are etymologically unrelated, but their affinity is more than phonetic. There is gamboling on the green and there is gambling on the green baize tabletop. Gamboling can break one’s gamba, or leg, and gambling can break one’s bankroll. Both activities are called playing, but they differ as horseplay differs from playing the horses.”
— W.V. Quine, “Quiddities: An Intermittently Philosophical Dictionary” (1987)
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