If I were newly placed in charge of the Fed, the first thing I would do is resign. Who on earth would want that job? If I couldn’t resign, then my first priority would be convincing the staff and fellow members of the FOMC to help me avoid screwing up massively. Let’s read the situation carefully and deliver actual policy innovations that are appropriate to it. Help!
I realize that approach is sort of obvious, and that the obviousness is a point against it. It is hard for a new guy to put his own stamp on the institution by saying let’s do what we have always done but just better. So, we have these fake debates around distantly tertiary issues like the optimal size of the balance sheet, which is truly minutia, or – as we have seen recently – communication strategy.
Oh, yes! History shows clearly that the Fed’s major failures, from the Depression, through the 70s inflation surge, the Global Financial Crisis and onto Covid, were for lack of presenting the dots properly. If only Arthur Burns had shared more or been quiet, all would have been fine!
Sorry for sarcasm, the lowest form of wit. But what makes this all particularly frustrating is that the media will focus on whatever they are told to, while Wall Street voices play along to feed the media. This week I learned that it might not be wise for Warsh to give up the bully pulpit. Really? That is what we should focus on? Seems unlikely. To cite just one simple and current example, we don’t need to know why Warsh claims to like the Trimmed Mean, unless it is coded language for ignoring the inflation target. What matters is if he is right to do so. He isn’t. And he won’t be made right any more by not talking about it than by insisting on talking about it.
To some extent, this focus on communication is vestigial – of the 2010s. In the wake of the Global Financial Crisis, the US was put into liquidity trap. One response to that was the invention of QE and the systematic overstatement of its relevance. A more serious response was resort to communication strategy, specifically an attempt to depress medium to longer-term interest rates by committing, in various ways, more or less, to keeping rates depressed for longer than they might otherwise have been expected to remain so. With the passage of time, the Fed leaned increasingly heavily on this tool, with what seems to have been increasing effect.
The ultimate expression of that approach came in the fall of 2021, long after the need for forceful Fed stimulus had passed, when the Fed committed to getting behind the curve on both the employment and inflation sides of its mandate. That was an extremely dovish policy innovation, which the consensus initially missed because they were focused on the balance sheet – although that fact has gone down the memory hole. And with the advantage of hindsight, the Fed’s willingness to embrace such a “time inconsistent” approach did lead to regret, followed by a combination of fibbing (to weasel out of the commitment) and a delayed tightening (out of residual respect for that commitment).
So, in the recent past, communication has been both potent and controversial. But in the current environment, liquidity trap is neither proximate nor considered a significant risk. So, communication or the lack of it is just far less important. The Fed has rates to cut if it believes that delivering easier financial conditions is appropriate. And there is no need for open mouth operations, because policy rate changes are the readily available and much more obvious tool.
I suppose you might say that this is a point for Warsh’s approach. I agree with the Chair that saying too much – about rates – might actually be unhelpful and might lead to anchoring and cognitive dissonance favoring policy errors. But it is a very minor point because no FOMC participants are making any commitments on rates right now, I think because they accept the logic of the points made immediately above. And this would seem to circle us back to that simpler point about just being right, regardless of how they express it.
I focus on rates guidance because when it is appropriate, in liquidity trap, it is probably the most important expression of how communication can matter. But there is another argument for the Fed communicating, which involves allowing the public to reason along with the Fed. Presumably this would reduce frictions in the policy transmission process. But it seems to me that there are two obvious points that bear emphasizing here. First, I assume it is obvious that the Fed being clear about its objectives, especially for inflation, is paramount here. So, anything that leads to confusion around that would be a loss.
Second, the Fed sharing its view of the world will be more helpful if the Fed is right, although I guess it might be helpful to some extent even if the Fed is wrong, to the extent that the public could figure that out. But much more to the point, this benefit would seem to require that the Fed be honest about what it actually believes. I mention this because since the GFC the noble lies in service of the greater good have been piling up, although I will skip the litany here to avoid being tedious.
Being more honest would be a communication innovation. Let’s see if they can pull it off. It is not remotely the main thing but it would be a win.
