The Federal Reserve’s Communications Strategy
Speaking in Jackson Hole, Wyo., this morning, Federal Reserve Chairman Ben Bernanke mentioned a number of further steps the central bank could take to ameliorate the dire economic straits the country is in. The second involved changing the Fed’s communications strategy. Here is the text of that portion of the speech:
[Another option] for the FOMC would be to ease financial conditions through its communication, for example, by modifying its post-meeting statement. As I noted, the statement currently reflects the FOMC’s anticipation that exceptionally low rates will be warranted “for an extended period,” contingent on economic conditions. A step the Committee could consider, if conditions called for it, would be to modify the language in the statement to communicate to investors that it anticipates keeping the target for the federal funds rate low for a longer period than is currently priced in markets. Such a change would presumably lower longer-term rates by an amount related to the revision in policy expectations.
Central banks around the world have used a variety of methods to provide future guidance on rates. For example, in April 2009, the Bank of Canada committed to maintain a low policy rate until a specific time, namely, the end of the second quarter of 2010, conditional on the inflation outlook. Although this approach seemed to work well in Canada, committing to keep the policy rate fixed for a specific period carries the risk that market participants may not fully appreciate that any such commitment must ultimately be conditional on how the economy evolves (as the Bank of Canada was careful to state).
An alternative communication strategy is for the central bank to explicitly tie its future actions to specific developments in the economy. For example, in March 2001, the Bank of Japan committed to maintaining its policy rate at zero until Japanese consumer prices stabilized or exhibited a year-on-year increase. A potential drawback of using the FOMC’s post-meeting statement to influence market expectations is that, at least without a more comprehensive framework in place, it may be difficult to convey the Committee’s policy intentions with sufficient precision and conditionality. The Committee will continue to actively review its communication strategy, with the goal of communicating its outlook and policy intentions as clearly as possible.
I actually think that changing the Federal Reserve’s communications strategy would be an excellent place to start. But rather than broadcasting an economic message to market sophisticates, I think the Federal Reserve should, in layman’s terms, scare Congress into action.
I’ve written this before. But attempting to motivate Congress to continue stimulus spending seems a good path for the Fed, mandated to pursue full employment. Why? The policy maneuvers the Fed is considering would have indirect effects and come with opaque downsides. (Maybe they would erode confidence. Maybe they would increase inflation. Maybe they would have the opposite effect intended.)
Having the government spend more has downsides to be sure: It would increase the deficit, and ultimately the national debt. But those downsides are knowable, predictable and marginal. And the impact of stimulus could be immediate. The worst possible outcomes seem to be that Congress does nothing and the Fed is where it started, or that the debt increases a fractional amount. With the unemployment rate likely to tick up through the fall and a double-dip increasingly possible, it seems worth it.