ROI-Is Fed communication broken — and can Warsh fix it?: McGeever

Whoever said talk is cheap wasn't speaking to a central banker. When it comes to monetary policy, what officials say can often be just as — if not more — important than what they ​do. As Kevin Warsh looks to shake up the Federal Reserve's communication strategy, it's useful to consider how "Fedspeak" has evolved and what risks the new chair may be taking. "Monetary policy is 98% talk ​and 2% action," Ben Bernanke was known to remark during his 2006-2014 tenure at the helm of the Fed. That’s a far cry ‌from the stance ​of his predecessor Alan Greenspan, who famously quipped in 1987: "Since I've become a central banker, I've learned to mumble with great incoherence. If I seem unduly clear to you, you must have misunderstood what I said."

Both understood the importance of central-bank messaging, but they approached it quite differently. Their communication styles reflected not only their personalities but also the economic and market conditions characterizing their respective terms leading the U.S. central bank. Bernanke, who steered the Fed through the 2008 global financial crisis (GFC), favored more communication, greater transparency, and clearer guidance. Greenspan, on the other hand, preferred more nuanced, ambiguous and at times cryptic signaling that came to be known as "Fedspeak." Other chairs fell ‌somewhere between those two poles. Take Paul Volcker. His no-nonsense bluntness kept most of the markets focused on his actions as he unleashed the most aggressive interest-rate-hiking cycle on record to slay inflation in the early 1980s. While all of these styles may have differed, what united these chairs was their pursuit of the Fed's dual mandate: maximum employment and stable prices, as now defined by a 2% annual inflation target. If Bernanke's arithmetic is accurate, those goals will be achieved mostly through communication. So it has to be good — or, more importantly, effective. This brings us to Warsh, who has been in the hot seat for only three months. He has vowed to shake up the central bank’s communications strategy, which he believes has swung too far toward the Bernanke end of the spectrum: too many speeches and public comments from Fed officials, too much "spoon-feeding" of information to markets, and too many policy meetings. One of the five task ‌forces he has set up to overhaul Fed operations is focused on fixing this. Its rather dull title – "Communications: Review how the Federal Reserve conveys policy deliberations and decisions amid uncertainty" – belies the huge market impact a radical shift in Fed communication could have.

In his Friday keynote address at the Kansas City Fed's annual symposium in Jackson Hole, Wyoming, Warsh said that "a quieter Fed, more purposeful in its communications, is better able ‌to meet its objectives." BEFORE AND AFTER

Over the past 30 years, Fed communication has evolved in the direction of greater transparency – even under Greenspan. In 1999, "The Maestro" oversaw the Federal Open Market Committee's move to issue a statement after every policy decision. But the major inflection point was the GFC. This crisis – the worst U.S. financial collapse since the Great Depression – marked a huge shift in how the Fed operated. It slashed interest rates to zero and pumped trillions of dollars of liquidity into the financial system via massive bond-buying, or so-called quantitative easing.

Explaining all that to the public – and keeping investors calm — was no easy task. Consequently, Bernanke’s Fed rolled out a host of new tools, and forward guidance truly came of age. He introduced the Summary of Economic Projections (SEP) in 2007, FOMC press conferences in 2011, and the much-maligned "dot plot" of officials' anonymized forecasts of key economic variables, including GDP growth, inflation, unemployment and interest rates, in 2012. The Bernanke Fed also formalized the 2% inflation target in 2012. That had been an assumed target since the mid-1990s but had previously never been made official.

On top of ⁠all this, the Fed chair ​delivers semi-annual testimony to Congress, there are press conferences after every meeting, minutes of every FOMC policy meeting are published, ⁠and Fed governors and regional Fed presidents give speeches and regular interviews to print and TV media. There are up to 19 participants in FOMC meetings, so that's a lot of public appearances. Too many, Warsh says. He might be right, but any transition will be difficult.

TOO MUCH OF A GOOD THING Most economists agree that frequent, clear communication and greater transparency are good things for central bankers. This should make policymakers more accountable, while also helping investors better understand the central bank’s "reaction function" — how it intends to achieve its goals. Most importantly, it ⁠can help anchor inflation expectations.

This is critical for keeping inflation under control because it can prevent wage-price spirals, in which the expectation of higher prices leads workers to demand higher wages, ultimately leading to faster inflation and the need for even higher wages. Clear communication can also help consumers, businesses and markets understand how the central bank might react to unforeseen developments, reducing uncertainty about the future path of interest rates. But others, like Warsh, argue this is part of the problem. Too much communication can create ​confusing noise. Excessive transparency risks being interpreted as predictability, breeding complacency and, in extreme cases, moral hazard, where investors make reckless bets knowing that central banks will ultimately come to their rescue.

And what if the signaling, or "forward guidance," is simply wrong? Inflation has been above the Fed's 2% target for more than 5-1/2 years. The Fed has said many times that it intends to get back to ⁠target, but the last time it raised rates was more than three years ago. The fed funds rate has actually been cut by 175 basis points since then. When the gap between rhetoric and reality grows, how effective is all that talking? In that light, you can see why Warsh wants a revamp.

SOUND OF SILENCE But he needs to tread carefully.

U.S. bond yields, especially long-dated and "real" inflation-adjusted yields, are historically high, and inflation is uncomfortably sticky. The term premium — the extra compensation investors demand for buying longer-term bonds instead of rolling over shorter-term debt — is flirting with ⁠its highest level ​in 12 years. This can be seen as a measure of perceived risk around inflation, the economy, financial stability or policy errors. Warsh hasn’t helped himself thus far. His second press conference after the July Fed meeting has been widely panned, as it left investors scratching their heads about what his word salad of business-speak actually meant. Most worryingly, he seemed to suggest that the Fed might not be clear about its inflation target.

The problem, though, is that scaling back signaling, messaging, and communications overall, however well-intentioned, risks creating a void. Rightly or wrongly, uncertainty and market volatility are likely to fill at least part of that space. Households, businesses, and investors may have grown too accustomed to policymakers' guidance, but isn't that better than flying blind? “I think we’re at a dangerous inflection point,” says Willem Buiter, an economist and former Bank of England policymaker. “Accountability is a key thing. Reducing the ⁠predictions offered by monetary policymakers collectively and individually would enhance market uncertainty and would make for worse economic outcomes.”

In the four decades preceding the COVID-19 pandemic, inflation and market-based interest rates were mostly trending down, as part of the so-called "Great Moderation." However, there were a few notable peaks amid that downward drift: when billionaire financier George Soros "broke" the Bank of England in 1992, following the September 11, 2001 terrorist attacks, and in the ⁠immediate aftermath of the GFC. There is nothing today remotely resembling these crises, but uncertainty around the Fed – its independence, credibility, and increasingly, ⁠communications – is rising to levels not seen in decades – and so are borrowing costs.

If the Fed truly wants to bring inflation to heel, it will likely have to raise rates. But just as importantly, Warsh will need to be able to communicate his willingness to do so and the framework for it. If he can’t do this effectively, risk premia are likely to remain elevated. "Amid such unease, silence from the Fed is deafening," says Jason Thomas, head of global research and investment strategy at Carlyle.

Whether Warsh likes it or not, markets need a message. In today’s environment, a failure to communicate is simply not an option. (The opinions expressed here ‌are those of the author, a columnist for Reuters)

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