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June 08, 2006

Non-Transparent Transparency?

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.

June 8, 2006 in Federal Reserve and Monetary Policy | Permalink


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The message is certainly subtle, to the point where I will even quibble with your clarification: “…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…” Instead of, “is not consistent,” how about, “if sustained, would not be consistent”? The way you say it, it seems to imply that the Fed’s current policy is failing, and that the public’s confidence is being belied by the facts on the ground. But I think you will agree that’s probably not the case.

Posted by: knzn | June 08, 2006 at 11:32 AM

Talk about transparency! Businessweek.com story sets stage to blame BB for housing demise, not industry-wide lending policies ENCOURAGED by the Bush Administration's "ownership society", not Fannie & freddie who greatly fed the out-of-control price escalation by buying absurdly risky mtg. loans, not Congress for refusing to supervise our GSEs, not even AG for advising borrowers to choose ARMs over fixed loans.

Posted by: bailey | June 08, 2006 at 11:55 AM

Markets read what they want to read. Maybe the Fed's language was too wishy-washy as markets got used to "well contained" inflation expectations, a phrase left unchanged for too long and therefore establishing a too positive and comfortable outlook. I cannot recollect FOMC statements/minutes since last summer that left much to interpretation. "Accommodative," "necessary fiscal discipline," "energy," "deficits;" it has been written all over the wall.
Surprisingly good headline GDP figures will buy the Fed another few months time to catch up with real inflation.
But what will happen once rates truly begin to choke over-leveraged consumers in a stalling housing market?
As investors rediscover the term "risk" after two decades of hunting for yield, the Fed is indeed in the position to deflate asset prices just by staying with the current message.
One should not forget in a longer-term perspective that we will always be left with the question what came first: central banks or economic cycles.
Recent history has shown that central banks can be successful in promoting a feelgood factor and probably even prolong the cycle on the upside.
But all of a sudden the Fed may find itself preoccupied with defending the value of the dollar, the lifeblood for the nation's import-based consumption.
Seeing absolutely no deficit and fiscal improvements the Fed has a mighty adversary in Pennsylvania Ave. that may ultimately foil its attempts to land the $ softly. The message from there is as clear as are the Fed's messages.

Posted by: The Prudent Investor | June 08, 2006 at 03:16 PM

Did you know that your name does not appear on your blog page, nor does it appear on your "About" page, nor does the one link on that page, which might give a clue about who you are, work?

Posted by: Hal | June 08, 2006 at 03:28 PM

I agree with you completely. The problem with being at "neutral" is that the road map is no longer certain. What is certain is that the Fed is far less likely to jump to conclusions from a given data release than the street. What I do know is that credit is not restrictive, and so market concerns regarding a cratering of growth is off base. Should they be worried about inflation? After so many years of feeding the world money, the funds had to start buying real assets at some point. Perhaps this is what has the equity markets spooked, revaluing p/e's for higher rates and not lower profits.

Posted by: steven Blitz | June 09, 2006 at 12:34 PM

That market fluctuations are heavily influenced by the comments of One Man makes me think that the Fed should get out of the business of setting interest rates. But, that's just me.

Posted by: Jake | June 10, 2006 at 08:00 PM

The post-Greenspan era uncertainty that we are seeing is exactly why so many were arguing that the Fed needed to institutionalize anti-inflation policy and transparency along the lines of the Bank of England, instead of wrapping it up in the "cult of personality."

Posted by: PEmberton | June 10, 2006 at 09:07 PM

I've noticed a divergence between fund managers' and traders' opinion of BB and that of many academics. Traders I talk to think he is a dove on inflation primarily because of his comments on possible deflation.

More than a few academics focusing on his academic leanings believe BB is an inflation targeter aiming at a 2% ceiling . Some of them worry that he may keep rates too high too long.

Too much focus is on BB's learning curve as Fed Chairman and not enough on money managers' learning about BB.

Posted by: trader walt | June 12, 2006 at 10:26 AM

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