Much as the Federal Reserve relies on “communication” and “forward guidance,” the task of clearly signalling its intentions to financial markets is not getting any easier in wake of the Federal Open Market Committee’s (FOMC) surprise decision not to reduce asset purchases on Sept. 18.
At the best of times, it is difficult to assess and forecast the economy, and for a central bank that claims to be both forward-looking and data-dependent — testing its projections against reality — that makes monetary policymaking tricky. These days, the exercise is further complicated by partisan wrangling over fiscal policy that is clouding the outlook.
“Fiscal drag” has transmuted into fiscal anxiety, making firms and households more uncertain than ever and hence more hesitant to hire, spend and invest. Never mind that the official data black-out attending the federal government shutdown makes it hard for the Fed even to measure the economy.
The debate rages on whether the Fed “misled” financial markets about the FOMC’s plans to reduce the $85 billion monthly bond buying. In his post-FOMC press conference, Chairman Ben Bernanke unapologetically told reporters, “I don’t recall stating that we would do any particular thing in this meeting.” And he said, “Fed actions are not determined by Wall Street’s expectations of what we might or should do.”
New York Federal Reserve Bank President William Dudley advised markets to “treat what we say as what we mean, don’t think that we’re hinting at something.”
But even some insiders concede the Fed was less than perfectly “transparent.”
Philadelphia Fed President Charles Plosser, among other officials, took umbrage, telling me “we did ourselves a disservice in this (communication) process in September.” He added, “We had set the market up for an expectation that we would start to wind down purchases in September.” Plosser serves on an FOMC subcommittee headed by Vice Chairwoman Janet Yellen.
When rates rose sharply after Bernanke’s June 19 statement that, if the economy performed as hoped, the FOMC expected to begin “tapering” bond buying “later this year,” Fed officials became concerned about the impact on housing. But Plosser contends they didn’t clearly convey those concerns and “push back” against market expectations of a September move.
While communication always can be improved, there are more profitable pursuits than laying blame — namely trying to figure out when and under what conditions the FOMC will begin scaling back its purchases of longer term Treasury- and mortgage-backed securities. Of course, that’s easier said than done in the current climate.
Since the FOMC said it wanted “more evidence that progress will be sustained” in labor markets, officials have been renewing their commitment to “data dependence.” But that begs the question of how much “more evidence” and over what time frame.
That’s a tough question to answer in a data vacuum. Even when statistical agencies start cranking out numbers on employment, retail sales, housing, inflation and so forth, there are sure to be varying responses.
For those policymakers, such as St. Louis Federal Reserve Bank President James Bullard and Governor Jeremy Stein, who regarded the Sept. 18 decision to stand pat “a close call,” perhaps it won’t take much to support a modest tapering. But for others, the bar is higher.
Dudley outlined two tapering tests: (1) “Evidence that the labor market has shown improvement,” and (2) “information about the economy’s forward momentum that makes me confident that labor market improvement will continue in the future.” Meanwhile, he said “the economy still needs the support of a very accommodative monetary policy.”
Boston Fed President Eric Rosengren sounded even less eager to taper. Asserting that he “strongly and unequivocally” voted to delay tapering and saying the economy is “just treading water,” the FOMC voter said “we need to see data that compellingly suggest that over the next three years we are indeed on a path to reach full employment and 2% inflation.”
Bernanke, who is expected to step down when his second term as chairman ends Jan. 31, 2014 and be replaced by Yellen, has had little to say publicly since Sept. 18, but did lament in early October that the recovery remains “frustratingly slow.”
Frustrating indeed. Despite holding the federal funds rate near zero for going on five years and expanding its balance sheet by a further $1 trillion over the past year, the gross domestic product has continually fallen short of Fed projections, languishing in a 2% growth slough that casts doubt on the economy’s ability to sustain “substantial” labor market improvement.
True, the unemployment rate has fallen to 7.3% from a peak of 10%, but that’s in good part to a plunge in labor force participation to 63.2%, its lowest level since 1978. Non-farm payroll growth has slowed to an average 148,000 over the past three months. And of course the inflation rate is running far below the 2% target.
Add the frustration of the fiscal stalemate and the damage it has done to confidence, and you have a prescription for further delay.