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September 20, 2006
Finding their voice: How transparent was today's FOMC statement?
OK, so they don’t completely know which way the economy is headed; not entirely unexpected, given that the US economy is almost certainly at an inflection point (although I like to see a bit more confidence from my central bankers, or at least another explanatory sentence). But I would expect the Fed to have a better handle on the inflation situation. Unfortunately, the third paragraph doesn’t leave me very confident on that front either. In the first sentence, energy prices have the “potential to sustain inflation pressures.” In the second sentence, inflation pressures are likely to moderate due to the “reduced impetus from energy prices.” What? WHAT!?! Are energy prices contributing to inflation or not? Shouldn’t the FOMC have an opinion on the impact of energy prices on inflation?
He's got a point. My reading of it was that they moved one of the statements about energy prices from the 2nd to the 3rd paragraph to reflect their thinking that energy prices are more likely to moderate and thus help us out on the inflation front rather than hurt us on the growth front. The line that energy prices have the potential to sustain inflationary pressures could be seen as a hedge. But that would beg the question of whether the press release is an appropriate place to hedge. I'm with Tim on that.
He also says,
In any event, this mixed message stuff is not exactly credibility enhancing.
I'll go so far as to say that the apparently contradictory statements on inflation are odd. However, divergent opinion (we know of one dissenting vote--we do not know the overall tone of the discussion) is not what could destroy their credibility. Of much greater long term consequence for their credibility is whether they follow through on what they say they will do--namely to address changes in the balance of risks according to new information.
Everyone needs to remember that transparency in the process does not imply certainty over the outcome.
Or, in a similar vein, ambiguity does not automatically mean less credibility. So, taking Tim's comments as a jumping-off point, it's time for a discussion of how much transparency we want from the Fed and how much ambiguity we can tolerate.
Let's cut to the chase. The ultimate in transparency (short of televising the meeting, which is most assuredly not going to happen) would be for the FOMC to release the "Greenbook" along with the press release. The Greenbook is the document that contains the staff forecast and is made public with the transcripts after a five year delay. Now we could debate whether it would be a good idea to make this information public. The point is that if we had that information along with the outcome of the policy decision, we would know in real time whether they are behaving in a manner consistent with a given (forward looking) policy rule.
At that point, for the sake of credibility, you might as well go all the way and institute a policy rule.
The increased transparency of the last decade has been very welcome. It has focused the spotlight on the Fed in a way that has disciplined the organization. When I look at what I teach my classes about the Fed from principles through the graduate level, I am often amazed at how much more sophisticated it is than was even possible when I was an undergraduate. We simply have more information, and we have that information instantly at our fingertips. When William Greider's Secrets of the Temple was published almost 20 years ago, the Fed was not subject to the daily scrutiny of the 24 hour financial press, the bloggers, and so forth. Public awareness and interest in the Fed is running quite high these days. Perhaps we can thank Greider for shining the light on the Fed. Certainly the mystique of Chairman Greenspan, especially after his handling of the 1987 stock market crash, had a lot to do with it. But ultimately it was the institution, led by Greenspan, that took on the challenge of making its actions known for the benefit of all. Even though they knew it might restrict them in the future. These are small steps towards a commitment mechanism.
However, the job isn't done. As the minutes of the August meeting make clear, the Fed is taking a long look at its communication policy. The experience of the last decade suggests that the more we know about what goes into the decision (this we learn from "Fedspeak") and the faster we know the decision (press releases and minutes), the less latitude they have to do things that are out of line with our expectations. Transparency enhances credibility at the cost of tying your hands. ("Measured pace," anyone?) However, tying your hands without a clear objective in mind could lead to trouble.
And so they should review their communication policy. Today's press release was a little problematic in the ways that Tim Duy points out. But even so, today's press release was more enlightening than the months worth of "measured pace" statements that, as I have said before, painted them into a rhetorical corner, unable to raise rates faster or slower than 25 basis points per meeting for fear of spooking the markets. That was not their finest hour in terms of communication skills either.
Personally I'd prefer that they release the Greenbook right away, issue a longer press release detailing some of the discussion of the Greenbook and clearly define their objective function. But that isn't likely to happen soon, so we will have to settle for some occasional abiguity to make sure that they don't get tangled up in their own rhetoric as they navigate between their dual, and sometimes conflicting, objectives.
UPDATE: New Economist is also unimpressed with today's statement.
Posted by William Polley at September 20, 2006 08:12 PM
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Comments
Releasing the Greenbook would not provide much information about whether the FOMC was following a particular policy rule. As you note, the Greenbook is a staff document and the staff has exactly zero votes on the FOMC. From speeches, it is clear that there is a diversity of views about the outlook among FOMC members; their votes should reflect thier views not the staff's.
My reading of today's statement with regards to inflation is that the FOMC believes that rising energy prices have contibuted to higher readings on core inflation, but given the path of future's indexes, this effect should wane and allow core to ease a bit over time. I don't think that it is particularly diffiuclt to interpret that portion of hte statement, particulalry given earlier statements. By contrast, the portion on the real outlook is quite difficult to interpret. Given the fact that they dropped the language about energy and intereest rates, it may be that they are saying that housing will bring growth below the Q2 rate, i.e. that past energy and interest rate movements led to an easing of growth to around potential and now the housing market is moving growth lower still. Alternatively, they could be saying that housing will keep growth at the moderate Q2 rate.
Posted by: rana at September 20, 2006 11:13 PM
Former Fed governor Laurence Meyer has mentioned the extent to which the staff forecast is analyzed and discussed by the FOMC members, especially the governors. The forecast models have been developed out of years of experience, and the staff are questioned rigorously during the meeting. (They are not the "views" of the staff but their research, and they do take care to keep it as objective as possible.) I think it is safe to say that the members take the forecast very seriously and attach a good deal of weight to it. Ultimately the votes of the members are based on their views but are informed by the Greenbook analysis.
I suppose it could be argued that the regional presidents' views could be subject to more variation due to the fact that they also have their own staff forecasts. But I would have trouble arguing that variation could swing the result of the whole committee. More likely it could explain the occasional dissent.
Research has been done on whether real time data like the Greenbook could allow one to better predict policy decisions. Evidence is not totally conclusive, but I haven't seen enough contrary evidence to reject the hypothesis. Orphanides (2001 AER) tries to fit a Taylor rule to Greenbook data and compares it to ex post revised data. The fit is better with the Greenbook (though not by much). Tootell's 1997 New England Econ. Rev. paper is a little more convincing. Romer and Romer (2000 AER) is perhaps the best evidence that the Greenbook forecast of inflation is better than what the public has access to in real-time. Overall, I'd have to say that I'd err on the side of having the information.
The European Central Bank is more open with its forecasts, and they also have a clear objective of price stability.
The July/August 2002 issue of the St. Louis Fed Review contains a number of good papers, a couple of which address aspects of this question. This is an active and unsettled research question.
I still think they are showing (perhaps appropriately so) their uncertainty about where inflation is going. It's pretty clear what energy prices have done, but what will they do and how much pass-through is left? I agree that there are multiple ways to interpret what is going on with real output.
Posted by: William Polley at September 21, 2006 12:39 AM
In the last paragraph above, "uncertainty" could mean wider confidence intervals around their forecast. I don't mean to imply that they are stabbing in the dark, but that there are more unknowns at this point in time than, say, a year ago.
Bottom line is that there are multiple ways to interpret both aspects of the release, and as Tim Duy and New Economist point out, that's not what we've come to expect.
Posted by: William Polley at September 21, 2006 01:01 AM
Although the Fed may have paused, the speculative bubble continues to try to inflate. The pundit doublespeak is as loud as ever. The talk about the impact of energy has turned from "much smaller impact than in the 70's" to "the reduction in energy will stimulate consumption".
Since the collapse of MEW, pundit talk has reversed from "the unprecedented boom in consumption caused by MEW" to " most people have traditional mortgages and will continue to spend normally". Dr. Copper is still at least 125 % overpriced because "China has uncoupled from the fortunes of it's major customer, the US". Celebration continues because "inflation is not accelerating as fast as before".
The Fed gets to sit back and watch with horror as the train wreck of speculative expectations they created and nurtured in the first 14 innings continues into the 15th inning, unabated by the fierce headwind of collapse.
Irrational, unstoppable, bubble mentality seems to be the cause of most recessions. The economy is unable to change to a new, healing economic model without a crash. The Fed's actions, it's wheel within a wheel role not withstanding, is usually a current symptom not a cause. Inflation causes Fed increases and ultimately a recession which causes Fed cuts which cause inflation ........
Posted by: quiz at September 22, 2006 12:30 AM