If Federal Reserve Chairman Ben S. Bernanke thought that helping investors to understand Fed policy was going to be easy, the past few weeks have disabused him of that notion. Comments he made last month unsettled financial markets and caused interest rates to spike -- an effect he hadn’t intended. Since then, he’s been trying to repair the damage.
Signs are that he made some progress in his semiannual testimony to Congress, which began today and continues tomorrow. Long-term interest rates eased a little as he reaffirmed the Fed’s commitment to maintain monetary stimulus. That’s fine, but Bernanke’s struggle to be understood raises the question of whether his dedication to transparency and “forward guidance” is wise.
It’s worth remembering that this approach is new. Judging by his speeches, Bernanke sees it as his distinctive contribution to the art and science of central banking. The previous generation of central bankers made a point of keeping markets in the dark about their interest-rate intentions. Alan Greenspan took pride in his turgid opacity; he once quipped, “If you think you understood me, it’s because I misspoke.” The prevailing theory was that interest-rate changes were more effective if they took markets by surprise.
Such thinking is now out. Increasingly, guidance is preferred and surprises are frowned upon. Bernanke is the most influential exponent of this thinking, but Mark Carney, the new governor of the Bank of England, pioneered it while running the Bank of Canada, and Mario Draghi, president of the European Central Bank, is moving tentatively in the same direction -- recently promising, in the manner of Bernanke, to keep interest rates very low for “an extended period.”
The essential difficulty in all this is that the markets’ appetite for information is limitless, and any central bank’s ability to satisfy it is limited -- both by economic uncertainty and by disagreement within central banks about the proper policy.
If a central banker says, “for an extended period,” the markets want to know, “How extended?” (Draghi tried to say more about that, then the ECB had to walk back the clarification.) Bernanke has attached various numbers for inflation and unemployment to his predictions for short-term interest rates and asset purchases, but that’s not good enough, either. For example, he said last month that 6.5 percent is the unemployment rate at which the Fed might start raising short-term interest rates -- but then again might not. It’s a “threshold” that would cause the Fed to reconsider its policy, you see, not a “trigger” that would force a change.
In the same vein, the great exponent of forward guidance this week told Congress that the Fed’s asset purchases “are by no means on a preset course.” He meant that everything depends on how the recovery evolves. But the markets knew that anyway. If central banks can’t or won’t bind themselves, more information doesn’t necessarily narrow the range of uncertainty.
Forward guidance can work as advertised when the central bank makes clear promises it intends to keep. A simpler approach that avoids multiple targets and triggers -- sorry, thresholds - - would work better. Forward guidance that has to be elaborated and refined every time a central banker speaks is, at best, useless.
Forward guidance could be worse than useless if it comes to be seen as a substitute for actual changes in policy. There’s a hint of this possibility in the U.K., where some expect Carney to rely less on quantitative easing and more on forward guidance about interest rates. Take this thinking too far, and forward guidance becomes mere bluffing -- which is destabilizing, because markets are apt to call any policy maker’s bluff. In central banking, as in most things, actions still speak louder than words.
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