Federal Reserve Chairman Ben S. Bernanke seemed a little nervous at his June 19 news conference. His recent comments about the future course of monetary policy had rattled investors and driven bond yields up, tightening financial conditions in a way the Fed didn’t want. Formally unperturbed, Bernanke said he was leaving policy unchanged -- but in trying, yet again, to elucidate the Fed’s thinking, he tacitly admitted that something had gone wrong.
Fortunately, the policy itself, I think, is basically good -- but that’s despite, not because of, the ever-evolving formulas used to explain it.
Growth in the U.S. is still sluggish, unemployment is still high and inflation is (a) running well below the Fed’s target and (b) falling. That suffices to justify interest rates at zero until further notice, together with additional large-scale asset purchases -- which is what the Fed intends.
There are dangers in this policy, to be sure. Quantitative easing is an experiment and involves risks. Bernanke summed these up drily in a recent speech: There’s the risk that long-term interest rates will remain low (leading investors to recklessly “reach for yield”) and the risk that they won’t (imposing losses on investors when rates rise and bond prices fall). The point is, in current circumstances, every course involves risk. Tightening monetary policy prematurely, as Bernanke has often explained, courts the greatest danger -- that of bringing a hesitant recovery to a stop. On a balance of risks, aggressive monetary stimulus still makes sense.
Yet the past few weeks showed that the Fed has a serious credibility problem. The central bank’s formal statement this week failed to acknowledge this -- it was essentially a reprint of the previous one -- but Bernanke’s news conference showed that the Fed is concerned.
Bernanke triggered the recent rise in long-term bond yields when he said last month that “in the next few meetings, we could take a step down in our pace of purchases.” You could argue that he was merely stating the obvious, but the markets took it as important new information. In itself, that needn’t have been troubling. The problem for the Fed is that investors didn’t interpret it as good news about the economy but as bad news about the Fed’s reliability.
As the economy strengthens, you’d expect long-term interest rates to rise. But the recent rise in bond yields coincided with unexciting jobs data and very low inflation -- inconsistent with the “strong economy” story. The implication is that investors thought the Fed was bringing forward its plans not just to taper QE but also, crucially, to start raising short-term interest rates.
Bernanke tried to address this confusion this week. He emphasized for the umpteenth time that the decision on tapering QE is separate from the decision on starting to raise short-term rates. All being well, tapering would probably start later this year, he said, with asset purchases continuing in 2014 until unemployment falls to 7 percent.
Interest rates won’t rise, the Fed has previously said, until unemployment has fallen to 6.5 percent. And, Bernanke added with fresh emphasis, perhaps not even then: These numbers are “thresholds” not “triggers.” So the Fed will merely start thinking about raising interest rates once unemployment falls to 6.5 percent, and might well choose not to act at that point. Oh, and it’s always possible, the chairman told another questioner, that the unemployment threshold for interest rates (and presumably therefore also for QE) will be revised -- more likely down than up.
Is that now clear?
In one way, the intention behind Bernanke’s latest elaborations is simple. He means to assure the markets that stimulus won’t be withdrawn abruptly or too soon. QE will be tapered as the labor market strengthens, but not stopped all of a sudden. Moreover, Bernanke repeats, a slower rate of QE is still stimulus -- as is no QE at all, for that matter, so long as the Fed hangs on to its existing stock of assets. Raising short-term interest rates lies even further in the future. Perhaps that message, Bernanke’s main point, got through: The Fed isn’t about to apply the brakes.
But if you ask under precisely what circumstances the stimulus will eventually start to be withdrawn -- which is what investors want to know, and is the message Bernanke keeps saying he means to impart with his commitment to “forward guidance” and transparency -- the new refinements really don’t help.
I sympathize. There are two underlying problems. One is the complexity of the situation the Fed needs to address. Consider just the labor market. You can measure its condition in many ways, and different indicators (narrow unemployment, broad unemployment, vacancies, hours worked, quits, hirings and so forth) will often give different readings. Central bankers don’t want to be tied to a simple formula when there are so many moving parts -- they want to retain some discretion.
Second, the Fed has many policy makers, not just one, and they often disagree. Forward guidance has to be vague enough to accommodate not just the complexity of future decisions in unknown circumstances but also the range of opinions on the Federal Open Market Committee. That vagueness, in turn, allows for bond-market glitches like the one of the past few weeks, as investors ask, “What on earth did the Fed mean by that?”
To repeat, the policy is right, and that’s the main thing. But Bernanke’s commitment to transparency and forward guidance has made his job harder. If he wants discretion under fire and the luxury of vigorous internal dissent, he can’t expect forward guidance to work as he envisaged. That’s why we’ll be debating what he really meant until he gives his next speech -- and that, if you’re wondering, is a threshold not a trigger.
(Clive Crook is a Bloomberg View columnist.)
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