The Wall Street Journal-20080114-Fed to Show New Openness On Outlook
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Fed to Show New Openness On Outlook
WASHINGTON -- Federal Reserve Chairman Ben Bernanke, responding to criticism that the central bank has sent confusing messages about interest rates in recent months, has decided to speak more forcefully and more often about the outlook for the nation's economy.
Reflecting the new approach, the Fed chief indicated in a speech last week that the economic outlook had deteriorated, with the housing slump and credit crunch spilling over to damp consumer spending and employment. His rhetoric suggested the Fed would cut interest rates by half a percentage point by the end of the month.
Fed officials are unlikely to cut rates before their scheduled Jan. 29-30 meeting, because Mr. Bernanke's speech has already recalibrated market expectations. But that could change if the outlook worsens sharply in coming days.
The Fed's new communications strategy comes after five months in which Wall Street analysts, academics and some former Fed officials have blasted the central bank for repeatedly implying it wouldn't cut rates further, and then doing just that, and for sending other contradictory signals. Some Fed insiders shared those concerns.
"They've more or less gotten to the right place [with policy]. They've just been erratic in getting there," says Stephen Stanley, chief economist at RBS Greenwich Capital, a bond-trading house. In official statements and speeches, the Fed "has been kind of swinging from one extreme to the other . . . . It's hard to parse out a center of gravity," he adds.
Top Fed officials dispute the criticisms but acknowledge it has been hard to deliver a consistent message because, as Fed Vice Chairman Donald Kohn put it in a recent speech, "the situation has been so fluid and so uncertain in its effects."
Nonetheless, either Mr. Bernanke or Mr. Kohn are likely to address the economic outlook in public at least once between policy meetings as long as the economic outlook remains unsettled. The idea is to help the market identify the Fed's central view without relying solely on comments from lower-ranking members of the Federal Open Market Committee, the group of Fed governors and regional bank presidents that sets the target for short-term interest rates.
There is speculation the FOMC met by conference call ahead of Mr. Bernanke's speech on Thursday, but the Fed hasn't confirmed any such meeting.
Mr. Bernanke's predecessor, Alan Greenspan, often dropped hints about changes in interest rates, and he dominated FOMC decisions. Mr. Bernanke, who took office in February 2006, has sought to make decisions more consensual and to avoid too many public hints about rates. In his first year, he addressed the economic outlook just five times, three of them in testimony to Congress.
Even in the wake of recent communications miscues, Mr. Bernanke hasn't tinkered with the longstanding tradition of letting other policy makers say what they want, in particular the 12 regional bank presidents. Their speeches, with occasional exceptions, aren't shared with Mr. Bernanke or his aides in advance.
Outsiders say this democratic atmosphere may be to blame for the Fed's mixed messages. "I think the Bernanke Fed is legitimately reacting to how overly controlled and personalized they were under the last few years of Greenspan," said Adam Posen of the Peterson Institute for International Economics, a Washington think tank. "They may have overcompensated and have to go back a little bit."
In early September, several FOMC members delivered remarks suggesting a preference not to cut rates, or to cut only a quarter of a percentage point. Because the Fed's leadership hadn't weighed in more clearly, the markets were surprised by the half-point rate cut later that month.
Laurence Meyer, a former Fed governor who is now a Fed watcher for forecasting firm Macroeconomic Advisers, says that, during times of upheaval, investors should discount remarks of FOMC members other than Messrs. Bernanke and Kohn, because comments from other officials "may no longer be operational."
In November, Fed governor Randall Kroszner and Chicago Fed President Charles Evans gave speeches strongly suggesting they weren't inclined to cut rates again, which was the consensus at the FOMC's late-October meeting. But markets had deteriorated since that meeting. Just days after those remarks, first Mr. Kohn and then Mr. Bernanke contradicted their colleagues in speeches that put rate cuts on the table again.
The episode reflected, in part, the failure of relatively new FOMC members to adequately hedge their comments, compounded by a more fundamental problem: the Fed's view of the economy has repeatedly been overtaken by events. At its Aug. 7 meeting, even as financial markets deteriorated, the Fed said it was principally concerned with inflation. Ten days later it released a statement highlighting instead its concerns about economic growth.
"There has been a continued belated recognition of problems," says veteran Wall Street economist Henry Kaufman, head of New York consulting firm Kaufman & Co. "They have not been ahead of the curve."
The Fed also has, occasionally, kept the markets in the dark -- to the consternation of those who lost money as a result. The most- criticized incident came on the afternoon of Tuesday, Dec. 11, when the Fed said it was reducing its main interest rate a quarter percentage point. But it didn't announce a deeper reduction in the discount rate, at which the Fed lends directly to banks -- something Wall Street had expected as a remedy for the credit crunch. The Dow Jones Industrial Average plunged nearly 300 points that day.
In fact, the Fed had developed and discussed an elaborate program to boost its lending to banks on Dec. 6, and formally approved it on Dec. 10. But it didn't announce the initiative until the morning of Dec. 12. Fed officials said they wanted to wait until European markets were open to coordinate the move with other central banks.
Lehman Brothers economist Drew Matus said Fed officials "gave the appearance they didn't care or they didn't understand" about market reaction even at a time of financial stress. "It just reinforces the perception that is out there that the Fed is out of touch, and that's really the last thing they need to reinforce right now."
But Mr. Posen, of the Peterson Institute, counters: "There's almost no reason the Fed should ever care about intraday volatility" in financial markets.
A related complaint from some analysts is that the Fed's post- meeting statements don't accurately reflect the tenor of the discussion. For instance, the December statement didn't disclose whether the Fed was more worried about slow growth or higher inflation, suggesting it had no inclination to reduce rates again. But the minutes issued later dwelt more on the risks to growth, a discussion more consistent with a bias toward cutting rates.
Fed officials say the time devoted in their meetings to an issue like inflation may not correspond to its importance. Dissecting the risks to economic growth may take far longer than assessing inflation risks due to high oil prices or a weak dollar.
Policy makers also say their public comments reflected genuine uncertainty over whether higher inflation or slower growth is the greater risk. In the past month, that has changed: Data on new-home sales, manufacturing activity and employment unambiguously showed the economy was weakening. That was the main reason Mr. Bernanke could deliver such a clear message last week, officials say.
