For the Fed, faith may not follow transparency
James Saft is a Reuters columnist. The opinions expressed are his own.
HUNTSVILLE — Wednesday was a weird day, caught somewhere between being a victory for the paranoid and a genuine step forward for openness and transparency.
And no, I am not talking about the sad spectacle of President Obama trotting out his birth certificate to assuage his deluded doubters. I am instead speaking of the Federal Reserve, which for the first time in its long history has taken the step of actually taking questions from the press after announcing its monetary policy decision.
Unlike the birth nonsense, there are two not mutually exclusive ways you can interpret the Fed’s decision to put itself at the mercy of the hacks. First, it is a real step forward for transparency, a step along the way towards renouncing the cant of the era of Greenspan, who seemed to regard himself as part economist, part Delphic Oracle and part Wizard of Oz. Second, it marks a waning of the power of the Fed, which has been diminished by its poor track record and by steps it took which opened it up to attack.
It is perhaps this second point which is more important; the Fed is under attack, under suspicion and trying very hard to husband its credibility. This is a tough combination of factors, and a state of play that could make it more difficult for the Fed to effectively fight inflation.
The most important weapon of any central bank is its credibility, which amounts to the faith that people have that it will follow its mandates. That’s not simply faith that a bank will do what it says, but belief that it can do what it says. For the Fed, which has a dual mandate to foster employment and keep a lid on inflation, this is sometimes nearly impossible. It may also not be something that is aided by transparency. Fiat money is a system of faith, and as many religions have found, faith and transparency don’t always mix.
“It used to be the mystique of central banking was all about not letting anybody know what you are doing,” Bernanke said during a notably uncomfortable performance in the press conference.
Quite right, it was not until the 1990s that the Fed actually began to announce its rate decisions. Before that they simply signaled them through market operations.
THE AGE OF DISBELIEF
The past decade has not been kind to the reputation of central banks, not least the Fed’s. Whereas once there was naive faith that economists, who played a cultural role not dissimilar to scientists during the early part of the Nuclear Age, knew what was best and would bring prosperity, now there is widespread doubt and distrust.
Wages have not grown, wealth has become more and more concentrated in a small sliver of the population and Americans have quite surprisingly not all grown rich by buying each other’s houses.
The central tenet of this belief system — the idea that enlightened management had brought on a Great Moderation of low-volatility growth — is now discarded. Many people distrust the Fed for having intervened too much, while others deride it for having done too little.
Will a press conference help to change this? Perhaps, but much of the problem is inherent in the situation and in the Fed’s dual mandate.
“So why not do more?” Bernanke said in response to a question about why he was not more aggressively fighting unemployment.
“The trade-offs are getting less attractive at this point. Inflation has gotten higher, inflation expectations are a bit higher, it is not clear we can get substantial improvements in payrolls without some additional inflation risks. In my view, if we’re going to have success in creating a long-run, sustainable recovery, we’re going to have to keep inflation under control.”
At one point Bernanke said that the longer unemployment persists the less it can be aided by monetary policy, saying instead it requires retraining, in a moment handing off some of his mandate to the Department of Education.
To be sure, to the extent that a press conference makes the views of the Fed more clearly known, it can help it in carrying out its intentions with a minimum of volatility and disorder. On this important measure, the conference was a reasonable success.
The larger issue is what happens when or if longer-term inflation expectations become unmoored and the Fed has to tighten meaningfully. When that day arrives I am not sure that a reasoned understanding of the competing pressures exerted on the Fed will actually increase the chances that they will be taken at their word.
I can’t help but think that would have been easier for former chairman Volcker in the bad old days of opacity than it will prove for Bernanke.
(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)