The Fed’s communication problem

The start of the FOMC’s November meeting is described in the minutes released yesterday as follows:

The meeting opened with a short discussion regarding communicating with the public about monetary policy deliberations and decisions. Meeting participants supported a review of the Committee’s communication guidelines with the aim of ensuring that the public is well informed about monetary policy issues while preserving the necessary confidentiality of policy discussions until their scheduled release. Governor Yellen agreed to chair a subcommittee to conduct such a review.

Here I provide some suggestions for Governor Yellen’s subcommittee to consider.

The Fed’s traditional policy tool is control of the overnight interest rate. But once the Fed brought this rate essentially down to zero at the end of 2008, the Fed’s main power has become irrelevant. According to economic theory, one of the most important ways in which the Fed might still be able to help the economy in such a setting is by successfully communicating today the strategy that it intends to follow in the future once it returns to targeting this rate at some value above zero.

It appeared for a while that the Fed had found a device for helping to frame such future expectations through its recently announced decision to resume large-scale purchases of longer-term U.S. Treasury securities. But as events have unfolded, it is becoming clear that political pressures will significantly constrain the Fed’s ability to exercise this option. Incoming Congressional leaders Paul Ryan (R-WI), Michael Pence (R-IN) and John Boehner (R-OH) are among those who have expressed strong opposition to the Fed’s plan. Not to be upstaged, Representative Dennis Kucinich (D-OH) plans to hold hearings next week on the Fed’s proposed $600 B purchase while the Democrats still call the shots in Washington.

The strength of this opposition may puzzle some within the FOMC. Traditionally, the Fed faced a trade-off between the goals of trying to keep both unemployment and inflation low. But at the moment, unemployment is painfully high by anybody’s standards, even as inflation is lower than the Fed feels is consistent with its goal of long-term price stability. Why is the Fed finding that persuading the public that inflation is too low is such a hard sell?

As Ben McCallum recently noted, regular Americans will tell you, of course inflation is still too high, because the price of X has gone up over the last year. Somehow the ability to process numbers that way fits naturally into our cerebral wiring, whereas averaging over all our purchases does not. There is also a deep-seated distrust of the official government measures of inflation. More fundamentally, many Americans think of inflation as an increase in the price of things they buy (which of course sounds bad), as opposed to an increase in the price of the things that they sell (which by itself is not that unpleasant). Perhaps the Fed should consider referring more to its desire to see wages and incomes growing more solidly, rather than its desire to see inflation higher.

Another key issue is that the public may not share the Fed’s vision that inflation and output are the only variables it should worry about. We have been going through financial and economic turmoil that is without precedent in the previous experience of most of those alive today. Who is to blame for what just happened? Many are taking the view that the Fed itself is to blame, arguing that excessively low interest rates fanned the flames of the housing bubble. Another popular perception is that the problem was created by reckless banks and financial institutions, which the Fed is committed to protecting from the consequences of their own actions, at the expense of regular citizens and taxpayers.

And what alternative to such stories has the Fed offered? The Fed’s operating principle seems to have been, “there’s a fire, we’ve got to put it out.” Now, I’m not going to argue with that as a decent principle. But it’s also worth asking, “how did the fire start?” And I don’t think it’s satisfactory to give as an answer, “stuff happens.”

My view is that there were multiple factors in the financial crisis, but that low interest rates from the Fed and inadequate regulatory oversight made a contribution. I think the Fed made some mistakes in both regards, and is making a further mistake today by not admitting those mistakes. The public needs more reassurance that we’re not just going to replay what happened during 2002-2005.

This leads to another area of communication in which I think the Fed could do better, which is communicating the limits of what monetary policy can be expected to accomplish. In part the public’s perception that the Fed caused the financial crisis in the first place is a response to a belief in the Fed’s omnipotence which Bernanke has done little to challenge. Indeed, even before the political maelstrom had pulled the rug out from under QE2, the earlier commodity price run-up had persuaded me that QE2 could not be pushed much farther. If we all understood that the game plan was, “here’s something that might help, but we’re not expecting miracles from it”, it’s one thing. But if the notion is we’re going to keep at it until unemployment is back to 7%, reasonable people should find that scary.

Here then is my suggested Fed communication strategy. The Fed should make clear that it is concerned about stagnating wages and income, that it has the tools to prevent a widespread deflation, and that it can and will prevent such a deflation. The Fed should also acknowledge that no policy it follows can reduce the unemployment rate to acceptable levels quickly, and that if the Fed were to attempt to do so on its own, it would create more problems than it solves.

And here’s my advice for how the Fed might approach the incoming congressional leaders:

Come now, let us reason together.

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23 thoughts on “The Fed’s communication problem

  1. 2slugbaits

    Come now, let us reason together.
    Unfortunately Sen. Mitch McConnell has made it abundantly clear that he is not interested in reasoning either together or in solitary. He just wants to make sure Obama is a one-termer. Not a very promising way to start a dialog.
    Somehow the ability to process numbers that way fits naturally into our cerebral wiring, whereas averaging over all our purchases does not.
    Anthony Downs would be proud. The Fed needs to learn how to speak to low-information voters in the same way that Fox News and CNBC desk jockies have found a way to communicate Ersatz economics. For the average or even above average citizen the cost of following economic developments is quite high. Not everyone can sit down each evening with a glass of scotch while curling up to the latest issue of one of the Fed’s research books in breathless anticipation of the Euler constraint on the next page. Just doesn’t happen. If voters even bother to follow economic issues at all it is more likely through the Glenn Beck/Sean Hannity axis-of-ignorance, or if they’re a few points up the IQ scale they’ll watch MSNBC spin some Big Business conspiracy theory. In any event, the hook is always the same; take simple, concrete, real world experiences that people can imagine might explain things and offer those anecdotes posing as data. The essence of the low-information voter is that abstract issues are too costly to understand, so people only relate to simple stuff that agrees with intuition and recent personal experience.
    But since the Fed isn’t in the habit of talking to the lumpenproletariat American people directly, but only in a mediated way through the release of minutes (Zzzzzz…) or through C-SPAN coverage of testimony (Zzzzz…Zzzzzz), it’s hard to imagine just how they would do this. Perhaps “The Bernank” should ask Matt Groenig to launch a Sunday evening show featuring cute cartoon characters.

  2. Spry

    You bring up an excellent point professor.
    I think what scares Bernanke and the Fed from admitting the limitations of monetary policy is a further loss in credibility. If they admit that they can’t solve the major problems with the economy and are unsure about the effects of their actions (QE2) then the public might start doubting the Fed even more and the politicians will put even more pressure on the Fed.
    I agree with your philosophy that the Fed needs to shed this image of omnipotence but it’s going to be tricky.

  3. Jeff

    Great post James. Regarding your point on the public’s perception of inflation, I wouldn’t be so quick to dismiss it as cognitive failures or distrust over inflation. In reality the CPI has been showing modest increases and wages have been basically flat over the last 12 months. This deterioration in consumers’ budget is real and something to cry foul over if one thinks the goal of the Fed is to help the average worker in this regard. And I think it would be a little misleading for the Fed to say we trying this QE2 thing to help “wages and incomes grow more steadily”. This just reinforces the notion that the Fed should be doing all it can to influence prices that work in the favor of the average worker’s budget. What’s the difference between that and the idea that the Fed should be concerned with food prices, energy prices, and medical costs because a rise in those things negatively impact consumers? Instead I would like the Fed to take a more honest approach and say “we will try to do what we can on the unemployment front to help the average worker but on the price front we aren’t so concerned about the average worker.”

  4. Tudor

    “Come now, let us reason together.”
    LOL! That’s the best joke I’ve heard in some time. It’s much more likely that the unicorns will come and show us the solution to all of our economic malaise. The fed is not in its current position b/c politicians are being reasonable with one another, but rather just the opposite.
    Really, the Fed should be independent of these considerations entirely. They should not be a political football to be kicked around because John Boehner doesn’t like their policy. It shouldn’t matter what he thinks about Fed policy, just like it shouldn’t matter what Obama thinks about Fed policy…that’s why we have an INDEPENDENT central bank.
    The Fed’s best response would be to send a very clear statement that it’s operating according to its charter independently of political considerations. They have no business reasoning with politicians, it’s antithetical to the Federal Reserve’s charter. They have their objectives and their policy is perfectly consistent with these objectives.
    Politicians can fight politicians all they want, the Fed has no business being involved whatsoever.

  5. Bob_in_MA

    “Perhaps the Fed should consider referring more to its desire to see wages and incomes growing more solidly, rather than its desire to see inflation higher.”
    Part of the problem is that there are really three types inflation:
    1. consumer price
    2. wage
    3. asset
    If the goal is to increase wages, the only one that matters is number two. But the only time a wage index seems to be cited is in regards to productivity, where low wage growth is seen as a positive!
    The Fed instead targets CPI inflation, which is really only “good” if it leads to similar or greater increases in wages. If it merely reflects commodity inflation and their is no commensurate rise in wages, the Fed has created a tax on consumers. Maybe targeting a lower CPI was popular when people feared inflation?
    They should publish a Wages Paid Index (or at least use more prominently the one the BLS already compiles) in conjunction with the CPI. When they want to raise rates, they could point to the CPI, in a situation like now, they could point to wages.
    But the big mistake was that in unveiling QE2, Bernanke, et al., made repeated reference to supporting asset price inflation, ostensibly hoping to use the wealth effect of asset price gains to juice spending.
    This is exactly the what they did with the last two bubbles. Both times it was very effective at increasing consumption, but in both cases the effect was ephemeral. By 2006, mortgage equity withdrawal was 4-5% of GDP. It provided us with a brief period of apparent prosperity, but when it reversed we had 9+% unemployment.
    What was the point? And how can they be so foolish as to target asset prices a third time?

  6. Jeremy

    JDH,
    Thanks. You phrased the problem well. However, “communication problem” may be just a euphemism for “credibility problem”. A problem created by the perception, right or wrong, that Fed actions in 2002 to 2005 as well as inadequate regulatory oversight contributed to the last crisis.
    Surely it is Fed credibility that needs to be re-established if taxpayers are to be convinced that a combination of QE2 and historically low interest rates will not simply lead to the next bigger bubble and crisis.
    After all isn’t that what happened the last time?

  7. Get Rid of the Fed

    “The strength of this opposition may puzzle some within the FOMC. Traditionally, the Fed faced a trade-off between the goals of trying to keep both unemployment and inflation low. But at the moment, unemployment is painfully high by anybody’s standards, even as inflation is lower than the Fed feels is consistent with its goal of long-term price stability. Why is the Fed finding that persuading the public that inflation is too low is such a hard sell?”

    How about because price inflation based on a middle class person’s budget is not too low, but spoiled, rich economists can’t understand this?

    Is most of this so called low price inflation mostly in tradable goods?

    What happened to all that garbage that there would not be enough workers when the baby boomers retired?

  8. Get Rid of the Fed

    “My view is that there were multiple factors in the financial crisis, but that low interest rates from the Fed and inadequate regulatory oversight made a contribution.”

    The problem is too much debt, period. However, economists can’t admit this because they come up with stupid statements like debt doesn’t matter because we owe it to ourselves, for every borrower there is a lender, and debt is a stock and not a flow.

    And, anybody that says debt is the lifeblood of an economy is nothing more than an economic and political hack for the spoiled and rich and the bankers.

  9. Get Rid of the Fed

    “Here then is my suggested Fed communication strategy. The Fed should make clear that it is concerned about stagnating wages and income, …”

    Utter nonsense. How about one of the reasons the fed exists to is prevent a wage bubble for at least 95% of the workers but not for economists, traders, and bankers?

  10. Get Rid of the Fed

    “Perhaps the Fed should consider referring more to its desire to see wages and incomes growing more solidly, rather than its desire to see inflation higher.”

    If you are actually serious about that, then what about more retirees to tighten up the labor market?

  11. Get Rid of the Fed

    “And here’s my advice for how the Fed might approach the incoming congressional leaders:

    Come now, let us reason together.”

    I’ve found there is no reasoning with economists especially the fed. Every recession and/or instance of price deflation is cured with more debt. There is no such thing as enough supply. bernanke said so in his price deflation speech.

  12. flow5

    The FED has made its communication clear. They pay the member banks twice, once on their excess reserves, and once again, by allowing the banks to create a multiple, of whatever volume, of new money and credit the bankers think would be potentially profitable.

  13. flow5

    The great German poet and playwright Bertolt Brecht said it was “easier to rob by setting up a bank than by holding up (one).” That says a lot.

  14. flow5

    We have an “elastic” currency “aided and abetted” by “elastic” legislators. We have perennial Walter Wriston caricatures pressuring the House Committee on Financial Services & the U.S. Senate Committee on Banking, Housing, and Urban Affairs. We have a conspiratorial organization that goes by the name of the American Bankers Association – with its well funded lobbyists.
    The Board of Governors is self-described as: “subject to oversight by Congress, which periodically reviews its activities and can alter its responsibilities by statute” Even so, the Fed is “connected at the hip” with Congressional allies, a la Greenspan, who the New York Times called a “three-card maestro”.
    The Fed’s research is politically coordinated, targeted to justify its monetary policy objectives – those that appease the banking community. It’s as the university professor said: “innovate away from home”. Academic freedom has become the “barbarous relic”.

  15. Dan Nile

    The Fed has no desire to see wages rise. When has any Fed official even hinted at that? In fact, wages rising is considered to be a sign that inflation is in danger of getting out of control and monetary policy needs to tighten.

  16. ppcm

    May I suggest to substitute “Come on let reason togather” for “Let me come to the innocents for the kingdom of God belongs to them”
    Still both themes are hard to deal with, when looking for innocents in the banking, financial markets,and moreover on subjects like:
    Inflation (see Econbrowser post M Chinn Inflation “Fears and Measures of Expected Inflation” )
    When thinking of the last supper may be sitting the central banks,where they should be that is among the apostles,would be the right level of most innocents expectations.

  17. econimus

    Most of the comments here are an exemplary demonstration of what the problem is. When people substitute feelings for facts (illustrated by the “but” whenever numbers are presented to show that there’s no such thing as “inflation” just fluctuating or volatile pricing in certain segments) you can’t talk to them. And I think, unfortunately for the federal reserve, that it doesn’t matter what is said to the public now. Let the politicians do and say what they may and stay above the fray.
    You’re right in that the statements should take on the wage character because you can’t really argue with that on the general public level. And that’s all they should do because they are right: there is no inflation. The numbers, if you don’t bend them to fit your political view or point to non-canonical ones that do, are the numbers. But a little marketing spin in the official statements to highlight wage and unemployment only now, would help the general public’s perception. And after this attack by the silly right wing, if I were Bernanke, I’d rip the R from the end of my voter registration faster than you can say Federal Open Market Committee.
    And remember your Zen – perception is reality.

  18. David Pearson

    JDH,
    Fed policy relies heavily on confidence in Fed policy. Saying, “this won’t do much” is like saying, “don’t change your expectations”. But the whole point is to change expectations. This is particularly true since the Fed is trying to influence markets primarily. It wants stocks up, and saying, “we might not be that effective” won’t do it. Markets require a “Maestro” once you start juicing them up, and Bernanke is trapped into becoming one, as will his successors. Contrast this with the untransparent Volker era, when the Fed spoke softly (or not at all) to markets and carried a large stick.
    One of the Fed regional presidents recently said (I’m paraphrasing), “the Fed is not here to make markets happy.” I think that was an exercise in wishful thinking.

  19. Raskolnikov

    Professor, How can the Fed win the public relations war when the opposition is saying that Bernanke is “printing a lot of money”?
    It seems to me that they have figured out a very effective way to discredit what the Fed is doing (pushing down long-term interest rates, which is hard to convey)

  20. Dr. D

    JDH, nice post. Regarding:

    My view is that there were multiple factors in the financial crisis, but that low interest rates from the Fed and inadequate regulatory oversight made a contribution. I think the Fed made some mistakes in both regards, and is making a further mistake today by not admitting those mistakes. The public needs more reassurance that we’re not just going to replay what happened during 2002-2005.

    I also enjoyed your “multiple factors” post; it’s especially good to see the econ side of the house coming up to speed with what we in finance have been doing. (Now if MC could dispense with the Bush ranting, maybe I could get back to reading this blog on a more frequent basis….)

    But I will mention one important point which you are still missing: in your overall very thorough “multiple factors” post, you overlooked the fact that the GSEs and the ABS/MBS securities had equity tranches and reserves. That is, the shadow banking system held reserves, just like the “real” banks.

    Through the course of my involvement with structured finance over the last 20 years, I continually compared structured finance versus banking institutions on a number of metrics, reserve requirements being one. It is not simple to calculate reserves in the structured finance realm (nor is it easy to calculate reserves given a raw balance sheet for a modern banking institution), but in my analysis, I found that reserves held in the structured finance realm were generally significantly greater than for the realm of “real” banking institutions.

    Given that reserve requirements have long been held as the very most important and most powerful mechanism for regulators to use in imposing prudence on banking, it seems to me that this needs to be looked at in much greater detail.

  21. Steven Kopits

    Reason is a function of your objectives. An action is ‘reasonable’ to the extent it achieves a given objective efficiently. If you want to decrease income disparities, high taxes are a ‘reasonable’ policy. If you want high GDP growth, low taxes and limited transfer payments are a ‘reasonable’ policy. These policies conflict, but both can be construed as ‘reasonable’.
    Are the objective functions of Democrats and Republicans the same? Or do they define success in different terms? And will Republicans not benefit if the Obama administration fails, even if it takes the US economy with it? Should politicans support ‘reason’ if it costs them their seats?
    To suggest that politicans ‘reason together’ is to try to finesse a critical issue: motivation. Are incentives aligned?
    I don’t think so.
    If you use a three ideology framework and principal-agenty theory, then disagnosing the problem and prescribing treatment is relatively trivial. Without it, you are left to blame politicians for their moral failings, for their venality and partisanship.
    When will economists come forward and take responsibility for the problem? When will the profession transcend its romantic view of politicans as our saviors, disinterested, wise and brave? When will economists conclude that politicians act on their own behalf, and not that of some unspecified ‘national interest’, and that without a proper framework of governance, democracy has critical weaknesses that voting, in and of itself, will not fix?

  22. dave

    What does your average person need?
    1) Food
    2) Energy/Oil
    3) Housing
    4) Medical Care
    5) Education
    6) Basic Consumer Goods
    Food, Oil, and Basic Consumer goods are tradeables that go up in price when the currency weakens. Since we do not sell them increases in those prices doesn’t support wage growth. Changes in currency rates are unlikely to result in a big revival of our competitiveness in those areas (especially oil, unless you can put it back in the ground).
    Housing has genuinely been cheaper, though for many people that’s an asset rather then a rent expense and as such its a mixed blessing.
    Medical care continues to skyrocket in cost.
    College continues to skyrocket in cost.
    So all the things people need are going up in cost. Things they don’t need are getting a bit cheaper. I can get a TV cheaper. Hotels are cheaper. Fancy meals (were labor is the primary cost) are cheaper. However, I always had the option to pare those expenses down because they are voluntary. The things I genuinely need in modern society are increasing in price, in some cases rapidly, and my ability to pay for them is not increasing. Increases in these things does not lead to an increase in my wages as I do not sell them.

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