The Fed and Communication

Ben Bernanke gave an interesting speech yesterday about Federal Reserve policy and communication. You can see the complete text here. Bernanke said that one of his goals as Fed Chair was to make the Fed more transparent. I think he’s done a good job there, but the markets were surprised earlier this year when the Fed didn’t start tapering as many folks had expected. I think this episode was the impetus for Bernanke’s speech.

Let’s step back and remember that an interesting quality of monetary policy is that expectations matter. The public has to believe that you’re credible for your policy to work. If they think you’re going to stand behind your policy, then the policy will be much more effective. This is also why there’s been a growing emphasis on targeting specific economic indicators.

Bernanke that explained that in response to the crisis, the Fed had lowered interests to 0%. While they couldn’t go below 0%, the Fed could communicate their intentions to keep rates down there for a long time. At first the Fed used language to convey their intentions (“some time” or “extended period”), but the market wasn’t getting the clue. So two years ago, the Fed started using specific dates, and Wall Street finally got the idea.

The Fed kept pushing out the date, so now the market was concerned about what indicators the Fed was watching. So last December, the Fed said, “Fine, here are some numbers, but don’t freak out. These are thresholds, not triggers.”

Here’s where Bernanke explained the troubles following his June presser:

Having seen progress in the labor market since the beginning of the latest asset purchase program in September 2012, the Committee agreed in June of this year to provide more-comprehensive guidance about the criteria that would inform future decisions about the program. Consequently, in my press conference following the June FOMC meeting, I presented a framework linking the program more explicitly to the evolution of the FOMC’s economic outlook.

(…)

The framework I discussed in June implied that substantial additional asset purchases over the subsequent quarters were likely, with even more purchases possible if economic developments proved disappointing. However, following the June meeting and press conference, market yields moved sharply higher. For example, between the FOMC meetings of June and September, the 10-year Treasury yield rose about 3/4 percentage point and rates on MBS increased by a similar amount.

(…)

(M)arket participants may have taken the communication in June as indicating a general lessening of the Committee’s commitment to maintain a highly accommodative stance of policy in pursuit of its objectives. In particular, it appeared that the FOMC’s forward guidance for the federal funds rate had become less effective after June, with market participants pulling forward the time at which they expected the Committee to start raising rates, in a manner inconsistent with the guidance.

To the extent that this third factor–a perceived reduction in the Fed’s commitment to meeting its objectives–contributed to the increase in yields, it was neither welcome nor warranted, in the judgment of the FOMC. This change in expectations did not correspond to any actual lessening in the FOMC’s commitment or intention to provide the high degree of monetary accommodation needed to meet its objectives, as Committee participants emphasized in subsequent communications.

At its September 2013 meeting, the FOMC applied the framework communicated in June. The Committee’s decision at that meeting to maintain the pace of asset purchases was appropriate and fully consistent with the earlier guidance. The Committee was looking for evidence that job market gains would continue, supported by a pickup in growth. As it happened, the implications for the outlook of the evidence reviewed at the September meeting were mixed at best, while the ongoing fiscal debates posed additional risks. The Committee accordingly elected to await further evidence supporting its expectation of continued improvement in the labor market. Although the FOMC’s decision came as a surprise to some market participants, it appears to have strengthened the credibility of the Committee’s forward rate guidance; in particular, following the decision, longer-term rates fell and expectations of short-term rates derived from financial market prices showed, and continue to show, a pattern more consistent with the guidance.

Posted by on November 20th, 2013 at 2:47 pm


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