The Bernanke Fed's Transparency Has Been Rather Opaque

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776 words. That was the length of the FOMC statement released after its October 30th meeting. At times it reads like an awkward English translation of a mathematical model. Key passages may appear clear to a group of monetary policy insiders but are plainly confusing for the uninitiated.

So accustomed have we become to these longwinded descriptions of all the contingencies and vagaries of monetary policy that we no longer remember how short the policy statements used to be.

In January of 2006, at the end of Alan Greenspan's tenure, the entire FOMC statement was only 216 words long. And 77 of those words were dedicated to name the voting members and offer a listing of Federal Reserve Districts.

Very much like now, this January 2006 statement came during a period of transition in Fed leadership, and near the beginning of a cycle of monetary tightening, when the need for policy guidance was particularly pressing.

Similarly, on March 18th of 2003, a day before the beginning of the war in Iraq, the FOMC statement was a mere 223 words long. At the peak of geopolitical risk, with the stock market down nearly 15% for the year, consumer confidence at a 10-year low, and an economy still reeling from the effects of the tech bust, the Greenspan-led Fed felt no need to offer a lengthy assessment of the policy outlook.

Communication of Federal Reserve's intentions is of course not restricted to these post-FOMC meeting policy statements, but they serve to illustrate the significant changes that took place in this area during Bernanke's stewardship of the institution. Is more communication better communication? With the memories of the recent swings in bond yields still fresh, it is hard to answer in the affirmative. The hard truth is that the detailed contingent policy analysis of the last few years has repeatedly proved bewildering, and has failed to deliver adequate guidance to financial markets. It now seems obvious that providing a lot of information is not the quite same as being clear.

Incoming Chair Yellen would be wise to consider whether offering a shaper and more focused message would not ultimately be more effective. What should this message look like? What do investors, firms, and bankers ask from the Fed? Ultimately they simply want an absolute price that can be used to anchor all financial decisions. Currently, this means a reference rate that helps to price a commercial loan, a 30-year fixed mortgage, or make an investment decision.

The committee clearly understands the importance of these decisions, and past declarations suggest it has some specific price targets in mind as well. Why then to choose to muddle them? For example, if the Fed currently has a target for the 2-year note, what is it? If there is a specific target for mortgage rates why not state it as well? Instead of promising to keep rates low for "an extended period", or until a specific date, why not simply say that monetary policy will seek to keep the 2-year note between say 25 and 35 basis points until the next meeting?

Complexity of mortgage contracts may make these rates difficult to target, but the Fed can probably define and track a specific benchmark. Or it can simply announce a range for the 10-year note instead. As we now know, asset purchases can always be adjusted as necessary to ensure that either or both of these targets are achieved.

Retaining some flexibility is important to conduct effective monetary policy and so the targets of policy will probably need to evolve over time. But the Fed should always be clear about what is actually targeting and what exact numbers it has in mind. To discuss anything else is confusing, no matter how many words are used to explain it.

The Central Bank of the United States is about to embark on the most challenging cycle of monetary policy tightening in over 30 years. Steering a fledging economy away from the gathering threat of new asset market bubbles, while avoiding plunging it back into a recession, will be an exceptionally complex task. Managing its message should not be.


Joao Gomes is the Howard Butcher III Professor of Finance at UPenn's Wharton School of Finance.  

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