Ben Bernanke, who led the US Federal Reserve during the global financial crisis, observed that the art of setting monetary policy was 98 percent talk and 2 percent action. A significant rebalancing of that equation would be welcome after communications upheavals this week roiled markets and seemed to reveal a high degree of anxiety among central bankers. While US Fed Chair Jerome Powell pledged to conquer inflation, and effectively conceded a recession may be the price for doing so, the process of getting to that point was messy.
Officials in economies big and small are facing a similar dilemma. Quashing inflation without inducing a severe slowdown is a tricky task in the best of times — and this is far from an ideal moment. Inflation has proven more pernicious than projected. Where policy makers are really tripping up is in signalling, or flat-out stating, what their next moves will be well in advance. Central banks then find themselves scrambling at the last minute to reset expectations — that they themselves created — when inflation isn’t behaving. No wonder markets are unnerved. Have central banks inadvertently created a beast that they now can't really control?
Consider all the fuss this week alone. The US Fed raised its benchmark rate by 75 basis points on June 15, a bigger move than expected until just a few days ago. Hours earlier, the European Central Bank convened an emergency meeting of its governing council — the scheduled conclave was only last week — to announce that it was hastening work on a tool to combat a surge in bond yields. On June 14, the head of the Reserve Bank of Australia went on prime-time television for a rare interview, where he signalled a period of substantial rate hikes lie ahead. Governor Philip Lowe had stressed last month that quarter-point increments were “business as usual.” Prepare as well for spontaneous hikes in emerging markets; Indonesia and Thailand look like prime candidates.
The question now is whether today's monetary chiefs dare dispense with some of the transparency to which they have allowed the public to grow accustomed — a practice that would have appalled predecessors, who preferred to speak in code and generalities. Forward guidance, the art of telling people what you will likely do with the price of money before you do it, worked when rates were around zero and inflation was quiescent. It’s clearly failing now.
After May’s Federal Open Market Committee meeting, Powell indicated moves of 50 basis points were his preference. He repeated this expectation in a number of interviews, which is why it seemed like a reasonable bet. It wasn’t until news articles on June 13, however, that the Fed signalled 75 basis points would be more likely. Stocks plummeted and bonds retreated across the globe. In his press conference on June 15, Powell said that the next hike would probably be either a repeat 75 basis point move or a return to the half point increase of May. Though he’s given himself more wiggle room, this may still end up being too specific. Markets recovered, but who’s to say gyrations won’t resume again? We have seen the grave shortcomings of forward guidance play out in real time this week.
For forward guidance to be credible today, as it was for much of the prior decade, a couple of key ingredients are needed. The first is clear messaging. This might sound obvious enough, but it becomes more difficult the more specific officials get. People hear a number — say, 50 basis points, or an inflation or employment threshold required for a rate change — and latch onto that, tuning out the qualifiers that come with it.
Another requirement is that the economy be in a condition that makes guidance possible with any degree of confidence. When Bernanke elevated forward guidance to something approaching an art form — a development embraced and enhanced by his successors at the US Fed and policy makers across the world — a plodding but lengthy recovery from the 2007-2009 crisis seemed like a reasonable scenario; inflation appeared contained. The world could be reasonably predicted, though it may not have looked like smooth sailing at the time. The past few years have been anything but easy to predict, thanks to the pandemic, the steep and short recession that followed COVID-19’s arrival, the rapid snapback and the attendant surge in inflation. The best days of forward guidance may be behind it.
Bernanke nodded to some of these difficulties when he began a blog at Brookings Institution in Washington in 2015, the year after he left the US Fed. “The downside for policy makers, of course, is that the cost of sending the wrong message can be high,” he wrote. “Presumably, that’s why my predecessor Alan Greenspan once told a Senate committee that, as a central banker, he had ‘learned to mumble with great incoherence.’”
Even Greenspan, for all his famous opacity, set central banking on a path to greater openness. In 1994, the Federal Open Market Committee began publishing written statements with its rate decisions. While this seems like a no-brainer today, it was revolutionary at the time. Greenspan came to appreciate that communications, if used selectively and timed correctly, could be a powerful tool in managing expectations of where interest rates and the economy were headed. Just not too much, mind you.
Forward guidance has put communications on steroids — and markets on an intravenous drip. While scaling back some of the excess will no doubt be greeted with howls, it may just return some power to officials. For all the tools at their disposal, central bankers have come to look like they are prisoners of their own statements and projections. Time to take back some control.
Daniel Moss is a Bloomberg Opinion columnist covering Asian economies. Views are personal, and do not represent the stand of this publication.
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