c.2013 New York Times News Service
c.2013 New York Times News Service
Last week’s announcement by the Federal Reserve chairman, Ben Bernanke, that the central bank wouldn’t immediately begin tapering its asset purchases seemed to be just what markets were hoping for: Stock and bond prices both rallied on the news, increasing the net worth of millions of Americans — at least until the specter of a fiscal cliff again raised its ugly head in Congress.
So why did the Fed’s action reap a blast of criticism?
Reuters said 33 of 48 economists it polled faulted the Fed for being “unclear” in its communications, adding, “It is rare for a consensus of economists to criticize a major central bank.” The Wall Street Journal said Bernanke’s announcement was “the latest in a series of communications missteps.”
But perhaps their ire would have been better directed at the lawmakers in Washington who are trying to shut down the government and are threatening to default on the national debt.
“Nobody knows what will happen with the budget and the national debt ceiling,” Alan Blinder, a professor of economics and public affairs at Princeton University and a former vice chairman of the Federal Reserve, told me this week. “The second of those is a major hazard to markets and the economy. It doesn’t take a genius to figure out that this might have given the Fed some second thoughts” about tightening.
The Fed’s action clearly surprised many professional investors, who were betting the Fed would start to tighten monetary policy, driving down stock and bond prices. When their bets turned out to be wrong, many of them aired their complaints with the Fed in the media.
The criticism plainly exasperated the usually unflappable Fed chairman, who has made greater communication and transparency a hallmark of his tenure. At a news conference Sept. 18, he said, “I don’t recall stating that we would do any particular thing in this meeting,” and added somewhat tartly that the Fed’s mandate is to do what’s best for the economy and not what’s best for a small group of professional investors.
“We can’t let market expectations dictate our policy actions,” he said.
Blinder agreed with the chairman.
“A small number of bond traders got burned by this, and when bond traders get burned they tend to blame the Fed,” he said. “And they should realize the Fed is not there to please them.”
At least some market professionals read the Fed’s signals right. Michael Hanson and Brian Smedley, analysts at Bank of America Merrill Lynch, presciently warned before the Fed’s meeting that “the markets believe a September taper is a done deal,” but “we anticipate the Fed will attempt to recalibrate market expectations at this meeting. In our view, the best way to do that is by not tapering in September.”
Bill Gross, Pimco’s founder and widely followed bond and interest rate expert, also warned that market expectations had gotten ahead of reality, suggesting the Fed was more likely to “tinker” than “taper.”
Justin Wolfers, a professor of economics at the University of Michigan who is currently at the Brookings Institution in Washington, told me this week that investors shouldn’t have been so surprised.
“Bernanke never promised to taper in September,” Wolfers said. “He always said the decision was data-dependent.”
It turned out that “the data were worse than when he first started talking about tapering.” And with a fiscal showdown looming in Congress, tightening monetary policy now would have been reckless, he said.
“There’s no reason to do it now when the Fed can wait a few months and see if this crisis is averted. Market professionals are whining about the Fed’s poor communication skills,” he said. “But the Fed has a clear statutory mandate, and keeping traders happy is not one of them.”
Even so, he and other economists I interviewed also agreed that Bernanke and the Fed bore at least some responsibility for the market’s confusion, especially given the Fed’s stated goal to reduce uncertainty and avoid market surprises. In June, Bernanke said that the Fed might begin to scale back its stimulus program before the end of the year, which many analysts interpreted as hinting at a September date. And he set a specific unemployment rate target of 7 percent for ending its monthly purchases of government bonds. Now, he’s saying the reduction in bond purchases might still begin before the end of the year, but he left open the option of continuing it beyond then. And he played down the importance of the unemployment data in setting Fed policy.
“It’s obvious people didn’t understand what the Fed’s strategy was,” said Michael Woodford, a professor of economics at Columbia University, and currently a visiting professor at Yale, who has written extensively about Federal Reserve policy. “If the goal was to create less uncertainty and have fewer surprises when a policy action occurs, then it hasn’t succeeded. In my view, it was a reasonable expectation that the Fed would reduce the rate of asset purchases in September. True, no one said that explicitly, but there were plenty of hints. What’s unfortunate is that it now sets them up for what they were trying to avoid. When they do make a policy change, it will cause a bigger negative reaction than it would have otherwise.”
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Blinder said he was among those who expected the Federal Reserve to begin tapering this month.
“Was I surprised? Just a little,” he said. “The data weren’t all that one-sided. It’s not like the economy was going to hell in a hand basket. But Ben Bernanke was very explicit that he was surprised at how much interest rates went up after his comments in June.”
And the stalemate in Congress, he said, was probably the final straw in causing the Fed to hold off.
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Few advocate a return to the days, not that many years ago, when the Federal Reserve said little, and routinely surprised markets with its actions. A large body of economic literature supports the notion that since markets anticipate future events, communicating its intentions is a valuable tool in the Fed’s arsenal. But part of the Fed’s current communications problem is that the central bank is operating in largely uncharted territory, both in its efforts to be more open and in trying to manage market expectations when interest rates are already near zero and have been for a prolonged period.
Wolfers pointed out: “Ben Bernanke said in his press conference that ‘We don’t have much experience with this. We can try to give you guidance. But we’re learning and things are changing.’ He was pretty humble. The Fed is literally learning on the job. But markets have to learn how to listen, too.”
Woodford agreed that “it’s obvious they’re experimenting with new approaches to communication.” He went on: “The habit of giving advance signals is relatively new, and the nature of the decisions is new. They’re not talking about a decision they’ve made before in similar circumstances. Quantitative easing is a new program. How do you unwind it? It’s not like we can look to past programs like this. They have to figure it out as they go. That may be why the market effects haven’t been what they were counting on.”
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Given the Federal Reserve’s evident challenges in communicating its strategies, I asked the economists what advice they’d give Bernanke.
“The problems come from not having said more and having said it earlier,” Woodford said. “The solution is not to clam up, which I’m afraid may be their immediate reaction. But that leads to a situation where the next moves will cause undesired and larger reactions. More communication is the answer, not less.”
Blinder suggested that talking about tapering in May and June was too early.
“Markets by their nature mentally rush things forward,” he said. “If you tell markets you’re thinking about tapering, they think you’re doing it on Tuesday. My second piece of advice is not to mention specific data and unemployment rates. Not that I want the Fed to be more mysterious. But as this illustrates, their decisions do not, in fact, hinge on just one number.”
Wolfers said the Fed needed someone like the “Mad Men” character Don Draper. The Federal Reserve’s statements “are simply confusing for all but the most highly trained monetary economists,” he said. “How would Don Draper simplify the message so that the public understood what Bernanke hopes to communicate, which is that the Fed is going to keep pushing the economy to go faster until times are good again? If he’s clear enough, we can all have confidence that times will, in fact, be good again, sometime soon.”