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June 08, 2006
Bloomberg's Caroline Baum puts her finger on the newest conundrum facing US monetary policymakers:
If the first test of central bank transparency is the elimination of market volatility arising from policy makers' comments, then Federal Reserve Chairman Ben Bernanke is quickly earning himself an `F.'
With the exception of the reaction to the May employment report on June 2, all of the big moves in interest-rate futures in the past six weeks came in response to something Bernanke (or the policy-setting Federal Open Market Committee) said publicly or privately.
Any of you following the markets closely or my recent obsession with the gyrations in market expectations -- here, here, here, here, and here -- certainly recognize the truth of that last sentence. Part of the issue is surely that the message policymakers are trying to send is somewhat subtle. Ms. Baum continues:
Traders and investors cry foul every time Bernanke opens his mouth. They complain that he says that inflation is "well- contained'' one minute and unacceptably high the next with no fundamental change to justify the shift.
The distinction that needs to be made is that "well-contained" refers to private-sector inflation expectations, as in this, from the FOMC's statement following the May 10 meeting...
As yet, the run-up in the prices of energy and other commodities appears to have had only a modest effect on core inflation, ongoing productivity gains have helped to hold the growth of unit labor costs in check, and inflation expectations remain contained.
... while "unacceptably high" refers to realized inflation. In this regard, what Mr. Bernanke said, in full, was this (with my own emphasis added):
Consumer price inflation has been elevated so far this year, due in large part to increases in energy prices. Core inflation readings--that is, measures excluding the prices of food and energy--have also been higher in recent months. While monthly inflation data are volatile, core inflation measured over the past three to six months has reached a level that, if sustained, would be at or above the upper end of the range that many economists, including myself, would consider consistent with price stability and the promotion of maximum long-run growth.
To paraphrase, yes we are pleased that the recent levels of measured inflation have not unmoored the public's belief in the FOMC's commitment to price stability. But yes, we also realize that the recent inflationary experience is not consistent with those beliefs -- or the Committee's own objectives -- and we do not take our credibility for granted. That's not exactly a simple message to convey, but neither is it contradictory.
But the bigger problem may be this one, once again identified in the Baum column:
Traders and investors seem to think transparency is laying out the interest-rate trajectory even when it's unknown...
I know that you know I am not a disinterested party in this debate. But, in all honesty, it appears to me that the messages coming from the FOMC have, as a whole, been perfectly consistent. A critical element of this message is this, again from the May 10 press statement:
... the extent and timing of any such firming [in monetary policy] will depend importantly on the evolution of the economic outlook as implied by incoming information. In any event, the Committee will respond to changes in economic prospects as needed to support the attainment of its objectives.
That economic outlook includes a complicated mix of clues about price pressures, strength in the real economy, and how that information influences people's expectations. I don't think monetary policymakers are speaking with forked tongues, but right now the data certainly are.
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