Jay Powell took Ben Bernanke’s advice a bit too far


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Ben Bernanke, who led the Federal Reserve during the global financial crisis, observed that the art of setting monetary policy was 98% talk and 2% action. A significant rebalancing of this equation would be welcome after the turmoil in communications this week rocked markets and appeared to reveal a high degree of anxiety among central bankers. While Fed Chairman Jerome Powell pledged to defeat inflation and effectively admitted that a recession could be the price, the process to get there has been complicated.

Those responsible for economies large and small face a similar dilemma. Crushing inflation without inducing a severe downturn is tricky at the best of times – and far from ideal timing. Inflation has proven more pernicious than expected. Where policy makers really stumble is in signaling, or outright stating, what their next moves will be well in advance. Central banks then find themselves scrambling at the last minute to reset expectations – which they themselves created – when inflation does not behave. No wonder the markets are pissed off. Have central banks inadvertently created a beast they can no longer really control?

Consider all the fuss this week alone. The Fed raised its key rate by 75 basis points on Wednesday, a bigger move than expected until just a few days ago. Hours earlier, the European Central Bank had called an emergency meeting of its governing council – the planned conclave had only taken place last week – to announce that it was speeding up work on a tool to combat a soaring bond yields. On Tuesday, the head of the Reserve Bank of Australia took to primetime television on Tuesday for a rare interview, where he signaled that a period of substantial rate hikes was ahead. Governor Philip Lowe had stressed last month that the quarter-point increases were “business as usual”. Also be prepared for spontaneous rises in emerging markets; Indonesia and Thailand appear to be prime candidates.

The question now is whether today’s monetary leaders dare to give up some of the transparency they let the public grow accustomed to – a practice that would have appalled their predecessors, who preferred to speak in code and generalities. . Forward guidance, the art of telling people what you are likely to do with the price of money before you do it, worked when rates were around zero and inflation was at rest. It’s clearly a failure now.

After the Federal Open Market Committee meeting in May, Powell indicated that moves of 50 basis points were his preference. He repeated this expectation in a number of interviews, which is why it seemed like a reasonable bet. It wasn’t until news reports on Monday, however, that the Fed signaled that 75 basis points would be more likely. Stocks fell and bonds retreated around the world. At his press conference on Wednesday, Powell said the next rise is likely to be either a repeat 75 basis point move or a return to May’s half-point increase. While he’s given himself more wiggle room, it can still end up being too specific. The markets have recovered, but who is to say that the fluctuations will not resume? We have seen the serious flaws in forward guidance play out in real time this week.

For forward guidance to be credible today, as it was for much of the previous decade, a few key ingredients are needed. The first is a clear message. This may seem pretty obvious, but it gets harder as officials get more specific. People hear a number — say, 50 basis points, or some inflation or employment threshold required for a rate change — and stick with it, stripping away the qualifiers that go with it.

Another requirement is that the economy be in a state that makes orientation possible with any degree of confidence. When Bernanke elevated forward guidance to something approaching an art form – a development embraced and reinforced by his successors at the Fed and policymakers around the world – a labored but long recovery from the crisis of 2007-2009 seemed like a reasonable scenario; inflation appeared contained. The world could be reasonably predicted, though it may not have looked like smooth sailing at the time. The last few years have been anything but easy to predict, thanks to the pandemic, the sharp and short recession that followed the arrival of Covid, the rapid return and the resulting surge in inflation. The best days of forward guidance may be behind it.

Bernanke nodded to some of these difficulties when he started blogging at the Brookings Institution in Washington in 2015, the year after he left the Fed. “The downside for policymakers, of course, is that the cost of sending the wrong message can be high,” he wrote. “Presumably that’s why my predecessor Alan Greenspan once told a Senate committee that as a central banker he had ‘learned to mumble with great incoherence’.”

Even Greenspan, for all his famous opacity, set the central bank on a path to greater openness. In 1994, the FOMC began publishing written statements with its rate rulings. Although it seems like a no-brainer today, it was groundbreaking at the time. Greenspan came to understand that communications, if used selectively and at the right time, could be a powerful tool in managing expectations about the direction of interest rates and the economy. But not too much, be careful. Foresight has put communications on steroids – and markets on an intravenous drip. While reducing some of the excess will no doubt be met with howls, it might just return some power to the officials. Despite all the tools at their disposal, central bankers have come to feel like they are prisoners of their own pronouncements and projections. It’s time to regain some control. More from Bloomberg Opinion:

• Late start on inflation traps Powell in dilemma: Jonathan Levin

• The Fed’s Narrow Path Between Inflation and Recession: Editorial

• Are central bankers telling us too much? : Daniel Moss

This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.

Daniel Moss is a Bloomberg Opinion columnist covering Asian economies. Previously, he was Bloomberg News’ economics editor.

More stories like this are available at bloomberg.com/opinion

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