A Simple Idea to Improve Fed Communication
(Bloomberg Opinion) -- Federal Reserve officials announced in November that they are conducting a review of “communication practices” as part of a larger reassessment of the conduct and effectiveness of monetary policy.
The reappraisal comes as most people, including first and foremost the Fed itself, are concerned about avoiding a repeat (as early as next month) of the type of miscommunication that contributed to the fourth quarter’s disorderly market sell-off. Any changes should aim to do more than simply add elements to enhance transparency and forward policy guidance. The central bank should also consider ending some practices that are vulnerable to repeated misinterpretations.
Long gone are the days of “Fedspeak” that involved, according to a famous remark by former Chair Alan Greenspan, “mumbling with great incoherence.” Instead, for more than 10 years, officials have pursued a path of greater transparency that provided markets with regular statements, numerical projections and, under Fed Chair Jerome Powell, a news conference at the conclusion of every FOMC policy meeting.
This approach is underpinned by the notion that a well-telegraphed monetary policy is more effective – not just because it helps avoid disruptive surprises for businesses and markets but also by having the private sector do some of the heavy lifting. At the same time, these efforts at openness sometimes result in mishaps that put the Fed in the tough position of either trying to ride out disorderly markets or, as has been consistently the case in the last few years, doing an embarrassing flip-flop to avoid market turmoil that undermines the real economy.
The central bank's strategy has potential drawbacks.
Some critics feel this approach exposes the Fed to one-sided risks that inadvertently distort monetary policy in favor of short-term asset-price gains and create longer-term risks of financial instability. That means the intended benefits could be offset by costs and risks. Others, including me, feel that some changes in the way the policy is conducted can improve the situation.
Among the immediate fixes that could be made to the Fed’s communication policy would be to eliminate the “dot plot” that shows individual policy makers' expectations for future rate increases as well as numerical estimates for economic variables. Instead, the central bank should pursue an approach that gives markets a better sense of the range of potential outcomes, including by providing the scenario analyses that inevitably accompany a responsive approach to policy making. This is warranted by the fact that central banks alone do not always control the outcomes they target under their mandate. Making the change is all the more important in today’s world of considerable cyclical and structural fluidity.
The Fed's dot plot can end up, inadvertently, fueling confusion. Although the data should be interpreted as tentative signals of the general direction of interest rates and economic activity, markets are inclined to treat even the smaller periodic changes as indicators of a significant shift in policies. As such, markets have imparted an illusory precision to the dot plot that no amount of accompanying Fed commentary has been able to properly qualify in practice. This challenge is accentuated not only by the unavoidable computation informality that underpins some of the individual projections but also by the market’s tendency to focus on the average rather than the range.
Certain market participants will undoubtedly complain that doing away with the dot plot would reduce the amount of information available. Yet, under Powell, the Fed has already shifted to a higher frequency of press conferences, allowing for more comprehensive review of salient policy issues. There is also the potential for the central bank to follow the example of the Bank of England’s “Inflation Report” by periodically releasing a more complete staff assessment of monetary policy conditions that stresses fan charts rather than point estimates. This could simply involve expanding, say quarterly or semi-annually, the staff discussion contained in the minutes, making it more readable for markets and supporting it with charts and figures.
Fed communication will never be perfect nor, some would argue, should it aim to be. But that is not to say there shouldn't be course corrections, starting with the evolution of the dot plot into something that is explicitly more conditional and scenario-based. This relatively easy step would help reduce the costs and risks of miscommunication; and it would do so at a time when the central banking community around the world is attracting more political scrutiny.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Mohamed A. El-Erian is a Bloomberg Opinion columnist. He is the chief economic adviser at Allianz SE, the parent company of Pimco, where he served as CEO and co-CIO. His books include “The Only Game in Town” and “When Markets Collide.”
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