By Richard Alford, a former New York Fed economist. Since then, he has worked in the financial industry as a trading floor economist and strategist on both the sell side and the buy side.
The US mainstream media (MSM) found a lot to like when the FOMC announced that its current highly accommodative monetary policy stance will continue unless certain “threshold levels” for unemployment and inflation are reached. While the MSM was not uniform in its praise, it applauded what it saw as the increased transparency in the design and execution of monetary policy. In comparison, the response of the market and the foreign press was muted, and comments by financial and economic bloggers were mixed. Juxtaposing a Binyamin Appelbaum article in the New York Times (serving as a stand in for MSM), the transcript of the Bernanke press conference, and a working history of monetary policy, it is clear that the enthusiasm of many in the MSM for increased clarity is misplaced. This in turn has less than flattering implications for the MSM, the Fed and its communication strategy.
Applebaum asserts that the current Bernanke FOMC is more transparent than its predecessors:
Over the last two years, Mr. Bernanke and his colleagues have announced a series of changes intended to increase the transparency of the Fed’s decision-making. Some of those moves have also transformed the way those decisions are made…
Several of those changes were tied together by Wednesday’s announcement that the Fed would hold short-term interest rates near zero as long as the unemployment rate remained above 6.5 percent and inflation remained under control.
Appelbaum places great weight on transparency and asserts that the Fed first employed transparency in 2003 with the aim of affecting long-term rates and the economy:
The Fed first experimented with this approach in 2003, when it announced that it would keep its benchmark rate at 1 percent for a “considerable period.
In recent years, since pushing rates nearly to zero in December 2008, the Fed has steadily elaborated on that idea. It promised to keep rates near zero for an “extended period.” Then it announced a series of specific timetables, most recently promising in September to hold rates near zero at least until mid-2015.
Appelbaum goes on to assert that the financial markets were uncertain of how the Fed would adjust policy prior to the advent of this transparency:
Until now, when economic conditions changed, markets were left to wonder whether Fed policy would change, too.
However, Appelbaum’s description of the evolution of policy transparency diverges dramatically from the historical record.
Policy transparency peaked under Volcker when the Fed targeted non-borrowed reserves as the money market target, the monetary aggregates as the intermediate targets. For proof of the transparency of this policy regime, one need look no further than the sometimes volatile market reaction to the weekly release by the Fed of its balance sheet (H.4.1), which reported the level of non-borrowed reserves in the system. One may believe that monetary targeting was not appropriate, but that is a different argument. During the era of non-borrowed reserve targeting, monetary policy was inherently perfectly transparent and observable on a weekly basis. Furthermore, policymakers adopted non-borrowed reserve targeting in part because of they believed that the policy regime and its inherent transparency would over time cause expected rates of inflation to fall more quickly. They believed that the declines in expected inflation would in turn support declines in long-term interest rates and thereby support real economic growth, but they relied on policy actions and not words.
Appelbaum also asserts that policy is more transparent under the current Bernanke regime than it was under both the earlier Bernanke regime and his predecessor Greenspan. However, monetary policy was much more transparent earlier in Bernanke’s tenure when policy was consistent with a Taylor Rule. Taylor-type rules are reaction functions that specify the Fed’s reaction to deviations of inflation and output from their targeted levels. The Fed kept the actual Fed funds rate very close to the level implied by its chosen variant of the Taylor Rule prior to the crisis of 2007. One can argue about the appropriateness of the specific Taylor Rule variant employed by the Fed or with the use of any Taylor Rule, but policy was transparent.
Contrast the transparency during the Taylor Rule regime with the current regime. The Fed now has threshold levels for employment and inflation, but does not specify how interest rate policy will be adjusted either before or after the thresholds are reached. Furthermore, caveats abound as evidenced in this statement by Bernanke at the press conference following the FOMC meeting:
Reaching one of those thresholds, however, will not automatically trigger immediate reduction in policy accommodation. For example, if unemployment were to decline to slightly below 6½ percent at a time when inflation and inflation expectations were subdued and were projected to remain so, the Committee might judge an immediate increase in its target for the federal funds rate to be inappropriate…
..the Committee recognizes that no single indicator provides a complete assessment of the state of the labor market and therefore will consider changes in the unemployment rate within the broader context of labor market conditions….
..the Committee chose to express the inflation threshold in terms of projected inflation between one and two years ahead, rather than in terms of current inflation….In making its collective judgment about the underlying inflation trend, the Committee will consider a variety of indicators, including measures such as median, trimmed mean, and core inflation; the views of outside forecasters; and the predictions of econometric and statistical models of inflation…
Finally, the Committee will continue to monitor a wide range of information on economic and financial developments to ensure that policy is conducted in a manner consistent with our dual mandate.
Bernanke and other believers in increased transparency see a continuation of a Taylor Rule-type reaction function regime. From the press conference:
So it’s really more like a reaction function or a Taylor rule if you will. I don’t want–I’m–I’ll get it–I’m ready to get the phone call from John Taylor. It is not a Taylor rule but it has the same feature that it relates policy to observables in the economy such as unemployment and inflation.
How can the current regime be said to have a reaction function when the policy regime either specifies no reaction to changes in the economic climate or does not specify a reaction? Perhaps Bernanke was channeling a Zen Kung Fu master: “Grasshopper, the optimal reaction function is to have no reaction function.” Furthermore, while at the press conference Bernanke said the new regime “relates policy to observables in the economy such as unemployment and inflation,” but he also listed caveats and indicated that unspecified and unobservable variables will also enter the calculus when policy changes are considered.
We are in unusual times. A hard and fast two-variable rule might very well be inappropriate, if it ever was appropriate. But let’s not pretend that the current policy regime is the high water mark of clarity or transparency.
The matter is further complicated by a distinction that Bernanke draws between interest rate policy and QE. While Bernanke and the FOMC assert that interest rate policy will be unchanged unless the threshold levels for unemployment and/or inflation are reached, the door to changing QE is left open. However, the condition under which QE purchases would be accelerated or unwound is left unspecified. To the extent that QE has an impact on economic activity, it is part of monetary policy, yet no reaction function is mentioned.
Appelbaum also favorably compares the current Bernanke regime with that of Greenspan’s. Ironically, he cites the following quote:
Since I’ve become a central banker, I’ve learned to mumble with great coherence,” Alan Greenspan, a former Fed chairman, told reporters in 1987. “If I seem unduly clear to you, you must have misunderstood what I said.
It is ironic because it was probably the only time during Greenspan’s tenure at the Fed that he was both honest and clear about policy pronouncements, while the current Fed is less clear about policy than it was before while claiming to be more transparent.
Why do many in the MSM function as an uncritical megaphone for the policymakers at the Fed? There are many possible explanations, but two are particularly salient. The first explanation is simply that the reporters do not have the knowledge or background to reach an independent judgment about monetary policy and simply repeat what people in authority positions tell them.
The second possible explanation is more troubling. Fed officials allow access and engineer leaks about policy via selected members of the MSM in return for uncritical coverage of policy or their view of what policy should be. In short, both sides have become “access whores.” Access to officialdom is swapped for favorable treatment in the mass media. In this explanation, the Fed and the MSM have co-opted and corrupted each other. The MSM has constitutional protections to allow it to function as a watchdog, but by swapping the willingness to be critical for access to the Fed they have become lap dogs and abdicated their responsibility to the public. As for the Fed, it has in effect told the public: “You can’t handle the truth.” The Fed communications strategy is aimed at managing and controlling the media and hence the public’s perceptions of policy and expectations about future outcomes. It is very Orwellian.