The Federal Reserve’s Hazardous Ambiguity
Andrew Levin, 31 January 2016
At its monetary policy meeting last Wednesday, the Federal Reserve reaffirmed its commitment to communicate to the public “as clearly as possible.” Nonetheless, the Fed’s recent communications have become increasingly opaque. For example, all of its prior statements since mid-2011 provided an assessment of the risks to the economic outlook, whereas its latest statement gave no such assessment at all. In diplomatic settings, such efforts at “constructive ambiguity” may be aimed at obscuring an underlying diversity of views. But the Fed’s current lack of clarity can only be described as hazardous. By exacerbating the uncertainty of households and businesses and contributing to volatility in financial markets, the Fed is undermining its own mission to foster maximum employment and price stability. Indeed, last week’s policy statement was woefully inadequate on several key dimensions of effective communication:
Too Much Stale Material. While the Fed’s policy statement was quite lengthy, at 500+ words, roughly 90 percent of that content was an exact repetition of the previous statement issued in mid-December. In effect, the Fed used roughly 60 words to characterize all of the economic and financial developments over the preceding six weeks. While somewhat reminiscent of the longwinded and opaque recitations of the Greenspan era, this approach is severely deficient at the current juncture. Of course, it may be impractical to mitigate that deficiency by overhauling the structure of the Fed’s policy statements. Thus, the simplest remedy would be for the Fed chair to start holding a press conference after every scheduled meeting, matching the practice that is already followed by the heads of the European Central Bank and the Bank of Japan.
Too Much Spin. Rather than providing an objective characterization of the data, last week’s policy statement seemed oriented towards rationalizing the Fed’s December rate hike. For example, the opening paragraph stated that “household spending and business fixed investment have been increasing at moderate rates in recent months.” That description not only glossed over December’s drop in core retail sales but was utterly inconsistent with recent readings on capital goods spending and nonresidential construction. In fact, last Friday’s GDP release indicated that business fixed investment declined nearly 2 percent last quarter -- the exact opposite of the Fed’s characterization. Will it really become necessary for the Washington Post’s renowned fact-checker to start assigning pinocchio ratings to the Fed’s policy statements?
Too Many Truisms and Codewords. The Fed’s previous assessment of “balanced” risks to the economic outlook was already a stretch in mid-December and completely untenable by early January. Rather than providing an updated assessment, however, its latest statement simply noted that the Fed “is closely monitoring global economic and financial developments and is assessing the implications for the labor market and inflation and for the balance of risks to the outlook.” Taken literally, this sentence would be a truism, because of course it’s always the case that Fed officials are carefully monitoring global developments. Conversely, if the phrase “closely monitoring” was intended to implicitly suggest greater uncertainty about the economic outlook and the path of policy, then why didn’t the Fed simply say so in plain language?
Too Much Complacency. Last week the Fed inserted a new sentence into its broad mission statement, indicating that Fed officials “would be concerned if inflation were running persistently above or below” the Fed’s inflation target. In some circumstances, such phrasing might be viewed as merely hypothetical and vacuous, given that policymakers can become “concerned” about practically anything. At the present time, however, this sentence seems oddly ironic, because actual inflation has indeed been running persistently below the Fed’s target for the past four years and is expected to remain subdued over the next few years. Thus, one is simply left wondering whether Fed officials are now concerned about inflation outcomes and prospects? And if so, what policy actions may be taken to mitigate those concerns?
Evidently, the Fed urgently needs to improve the clarity of its communications. Just like any trusted family physician, Fed officials need to present the facts plainly, characterize the uncertainty about the current diagnosis, and explain what steps will be taken to address any significant adverse scenarios that might transpire. Such an approach cannot be a panacea but will surely provide some greater reassurance to households and businesses and thereby promote maximum employment and price stability.
Andrew Levin is a professor of economics at Dartmouth College. Previously, he spent two decades on the staff of the Federal Reserve Board and was a special adviser to the Board on monetary policy strategy and communications from 2010-2012.