The Importance of Communication
The first order of business discussed in the Minutes from the last FOMC meeting in July was the formation of a ‘New Subcommittee on Communications’. It seems reasonable therefore that we begin this report on that topic. First, this subcommittee was appointed by Chair Yellen in the interim period between the June and July FOMC meetings. It is possible therefore this subcommittee offered some input at the July FOMC meeting. More likely however is that this subcommittee will give its first briefing at the September FOMC meeting or later.
Secondly, little was noted in the press about the formation of this subcommittee, whose attention was likely diverted by the lengthy discourse on the business of monetary policy normalization also included in the Minutes of the July FOMC meeting. In circles where monetary policy is discussed, policy normalization is currently a lot more ‘sexy’ then communication. However, if the process of normalization is to be successful and at all smooth, it will require considerable linguistic agility.
Finally, we should recognize the importance that Chair Yellen attaches to communication, quite likely furthered when, as then Vice-Chair she led the last subcommittee tasked to review this issue. Recognizing the importance of this topic, I dedicated much of my last FOMC Report[i] to the analysis of her April 2013 speech ‘Communication in Monetary Policy’ which was instructive in learning her views on the normalization of monetary policy. Communication in monetary policy, whether appreciated or scorned has become integrated as never before into the fabric of monetary policy implementation. Chair Yellen, in her April ’13 speech[ii] indicated; ‘The FOMC had journeyed from "never explain" to a point where sometimes the explanation is the policy‘, leaving little doubt the importance she places on communication.
Today’s most widely talked about Federal Reserve monetary policy issue is whether or not the Fed at this meeting will communicate its intentions for the policy rate using the now familiar term ‘considerable time’. Intended or otherwise, within the decision process on the timing of policy rate lift-off, the term ‘considerable time’ has become a touchstone for Fed policy intent in general.
There are good reasons for keeping the ‘considerable time’ language and strong argument for removing. Because the new subcommittee on communications is likely to have some input on the matter, either individually or collectively at this or subsequent meetings, we might review the members of this panel as relates to their tendencies regarding monetary policy communication and guidance.
The subcommittee is comprised of two members from the Board of Governors (Stanley Fischer and Jerome Powell) and two District Bank Presidents (Loretta Mester (Cleveland) and John Williams (San Francisco)). Among the four, only Williams does not currently vote on policy matters. Having succeeded Yellen at the Federal Reserve Bank of San Francisco, Williams is seen as supportive of her views on the importance of communication as a policy tool.
In February at the Money Marketeers of NY University[iii] Williams spoke favorably of a return to qualitative guidance, offering; “…our forward guidance should be aimed at providing the public with a good understanding of the key drivers of our policy decisions.” At the March FOMC Meeting shortly after that speech, the Fed dropped the quantitative ‘threshold guidance’ for date-referenced ‘considerable time’.
The most senior member of this subcommittee, Vice-Chair Fischer, has indicated a dislike for forward guidance[iv]. Having had experience using forward guidance as Governor of the Bank of Israel he found it ‘restricted the bank’s future actions when circumstances changed.’ He has offered further; “You can’t expect the Fed to spell out what it’s going to do,” “Why? Because it doesn’t know.” and “We don’t know what we’ll be doing a year from now. It’s a mistake to try and get too precise.”
Fischer is in a very good position to retard or help to reverse the trend toward ever-increasing levels of guidance. Fischer’s arrival as Vice-Chair of the Board of Governors, in advance of a shift toward lesser amounts of accommodation may be quite timely. He can present from a position of experience a convincing view of the dangers of excessive guidance. As needed levels of monetary policy support diminish on the achievement of stated policy goals, the Fed may have by then learned to communicate without outlining too concisely the outlook for longer-timeframe policy intent.
The Federal Reserve Bank of Cleveland’s new President, Loretta Mester recently called for forward guidance change[v]; "I believe it is again time for the Committee to reformulate its forward guidance," adding "…striving for clearer communication will yield benefits, especially as we undertake normalization", a process she feels is complicated by the size and duration of SOMA holdings. Considered to have hawkish tendencies, Mester will likely side with Fischer in the interest of using less forward guidance overall in policy communication.
Finally, Fed Governor Jerome Powell rounds out the new subcommittee on communications. Powell, days before taking oath of office in June to begin a fresh 14-year term on the Fed Board, spoke out in favor of forward guidance[vi]; ‘In my view, forward rate guidance has helped reduce medium and longer-term interest rates, and by doing so has provided meaningful support for the economy. First, by increasing public understanding and market confidence in the path of rates, guidance has helped reduce term premiums. Second, by communicating that rates would remain lower for longer than market participants might otherwise have expected, guidance has lowered medium- and longer-term rates through the expectations channel. Finally, even when guidance has initially been well aligned with market expectations, it has reduced the likelihood that rate expectations will subsequently shift upward in ways that the Committee does not intend. Event studies as well as market-implied quotes and surveys corroborate the view that guidance has reduced medium- and longer-term interest rates and has held down volatility as well. To be sure, there have also been times when forward guidance and market expectations have diverged, with resulting spikes in volatility. Such situations may be difficult to avoid, given the use of new, unconventional policy tools, although we always try to communicate policy as clearly as possible. ‘
A very crude interpretation of the above would place Messrs Powell and Williams together leaning toward continued use of forward guidance and for Mr. Fischer and Ms. Mester calling for less. Although the time is not now upon us, Vice-Chair Fischer is expected eventually to win out, prompting the Fed to scale back on its forward guidance as it moves more deeply into the process of accommodation removal. Should he fail however in that effort, the repercussions may be quite similar to the last time (mid-’04 to mid-’06) the Fed used too much forward guidance (‘measured pace’) while ‘intending’ to be less accommodating (see ‘The Dark Side of Fed Transparency’[vii]).
Process of Normalization Doesn’t Now Include Dropping ‘Considerable Time’
The best argument for dropping the use of date-referenced ‘considerable time’ language in the September FOMC meeting Statement is that ; There appears to be less need ‘to support continued progress toward maximum employment and price stability, as the Committee today need not reaffirm its view that a highly accommodative stance of monetary policy remains appropriate.’ Further, ‘The Committee having assessed the progress--both realized and expected--toward its objectives of maximum employment and 2 percent inflation has determined that continued support, need not include the maintenance of the current 0 to 1/4 percent target range for the federal funds rate for a considerable time.’
To be frank, the market is just not ready for a message that is ‘interpreted’ as indicating a relatively soon lift-off date. Instead, the Fed will continue to use the term ‘considerable time’ until a very strong majority has denounced its value in describing appropriate monetary policy guidance - most likely at December’s FOMC meeting. Adherence to this December meeting schedule will allow the Fed to remove the ‘considerable time’ language with the result being a collective, thankful sigh by economic agents instead of a strong and unwanted upward adjustment in interest rates and a reduction in levels of supportive risk assumption if the Fed were to spook market participants by dropping the language too early.
It is not necessarily appropriate that economic agents place such importance to the term ‘considerable time’. Clearly the Fed has outlined extensively the conditions that shall be expected to prevail when it believes excess accommodation will be less needed. While progress toward those goals has been keen, repeated overestimation of forward economic prospects has persuaded many Fed officials to allow slightly overstimulative policies to remain in place beyond their time rather than dismissed prematurely.
Recognizing that benefits in keeping current Statement language outweigh its removal, the Committee will, with some grumbling on both sides of the aisle, elect to maintain the date-reference ‘considerable time’ reference.
Policy Prescription Further Afield
As earlier indicated, the Minutes of the July FOMC Meeting gave considerable attention to the process of ‘Monetary Policy Normalization’ prompting me to offer an analysis of the Minutes[viii]. Below are some points that deserve additional attention (italics, bold and underline are my additions):
- ‘Meeting participants continued their discussion of issues associated with the eventual normalization of the stance and conduct of monetary policy, consistent with the Committee's intention to provide additional information to the public later this year, well before most participants anticipate the first steps in reducing policy accommodation to become appropriate.’ The Fed will bring forth additional information on how they intend to normalize the stance and conduct of monetary policy. They will not provide that information in the September FOMC meeting Statement nor will they give a specific outline of the process in the Minutes for the September meeting. Instead, they will provide that guidance ‘later this year’, probably in October, but possibly not until the December Meeting. Otherwise they would have said ‘soon’ to indicate September.
- ‘The staff detailed a possible approach for implementing and communicating monetary policy once the Committee begins to tighten the stance of policy.’ The Fed has ‘the’ exit strategy fairly well hammered out as indicated by the staff providing only ‘a’ single possible approach. There were two meeting participants seemingly not fully onboard, but they will be swept along with a consensus vote. The Fed is capable of presenting this exit strategy today, but will wait for a time when they can provide that information together with some additional guidance which is intended to be supportive, such as an intention to refrain from outright portfolio sales until at least 2018.
- ‘In general, they agreed that the size of the balance sheet should be reduced gradually and predictably.’ The Fed will at some point make available a ‘policy path’ description of the reduction in the reinvestment of principal and interest, thus providing some level of communication support despite the action of discontinued reinvestment as otherwise being less accommodative. This approach is consistent with that used for the ‘policy path’ reduction in securities purchases; otherwise know as ‘tapering’.
Connecting the Dots
The Fed has consistently scaled back its estimate for ‘longer run’ GDP growth and recently scaled back its estimate for the appropriate longer run or equilibrium target policy rate. It is difficult to call the timing to the end of this trend. Many feel there is room for further reduction to both in the updated release of the Summary of Economic Projections (SEP) provided at this meeting. Currently the longer run real GDP forecast is 2.1-2.3% as a central tendency. This central tendency forecast was as high as 2.3-2.5% as recently as June of last year. Similarly, the longer run SEP forecast for targeted fed funds rate was 4% since 2012 and reduced to 3.75% at the June, 2014 meeting.
References for longer run real GDP and targeted fed funds rates are not expected to come lower at this meeting. Additionally, there is room for the SEP expectation for year-end policy rates for 2015 and 2016 to move slightly higher from 1.13% and 2.5% respectively in June. The initial SEP forecast for year-end 2017 target fed funds rate may be very near or even at the longer run 3.75% latest posting.
[i] Martin McGuire; The Fed and Interest Rates; FOMC Report July 29-30, 2014; http://www.thefedandinterestrates.blogspot.com/2014_07_01_archive.html
[ii] Vice Chair Janet L. Yellen; At the Society of American Business Editors and Writers 50th Anniversary Conference, Washington, D.C. - April 4, 2013; ‘Communication in Monetary Policy’ http://www.federalreserve.gov/newsevents/speech/yellen20130404a.htm
[iii] Federal Reserve Bank of San Francisco; February 19, 2014; ‘Fed’s Williams Talks Qualitative Guidance’ http://www.frbsf.org/our-district/press/news-releases/2014/economic-conditions-monetary-policy-transition-speech/
[iv] The Wall Street Journal; September 23, 2013; ‘The Key to Forward Guidance? Don’t Give It, Fischer Says’; http://blogs.wsj.com/economics/2013/09/23/the-key-to-forward-guidance-dont-give-it-fischer-says/
[v] Reuters; September 4, 2014; ‘Cleveland Fed’s new chief calls for forward guidance change’; http://www.reuters.com/article/2014/09/04/us-usa-fed-mester-idUSKBN0GZ25F20140904
[vi] Governor Jerome H. Powell; At the 2014 Spring Membership Meeting, Institute for International Finance, London, United Kingdom - June 6, 2014; ‘A Conversation on Central Banking Issues’; http://www.federalreserve.gov/newsevents/speech/powell20140606a.htm
[vii] Martin McGuire; The Fed and Interest Rates; ‘The Dark Side of Fed Transparency’ – FOMC Report October 25, 2006; http://www.thefedandinterestrates.blogspot.com/2006/10/dark-side-of-fed-transparency.html
[viii] Martin McGuire; The Fed and Interest Rates; ‘Analysis of Minutes of the Federal Open Market Committee; July 29-30, 2014; http://www.thefedandinterestrates.blogspot.com/2014/08/analysis-of-minutes-of-federal-open.html