‘Transparent’ Vision: Bernanke, New Fed Chairman, Hopes to Downplay Impact of His Words
Mr. Bernanke Tries to Push Democracy at Central Bank; Setting Inflation Goals — A ‘Two-Handed Intervention’
By Greg Ip
8 September 2006
The Wall Street Journal
(Copyright (c) 2006, Dow Jones & Company, Inc.)
At Federal Reserve meetings under Alan Greenspan, the chairman would state his recommendations for interest rates. Then the 18 other policy makers would say if they agreed. They usually did.
After Ben Bernanke took over in February, he made some subtle but significant changes. When Fed officials debate the interest-rate decision, he speaks last. Fed officials say it makes them feel freer to talk about what’s on their minds, rather than responding to the chairman’s views. When Fed policy makers submitted their projections for growth and inflation as part of a twice-a-year report to Congress, Mr. Greenspan wouldn’t submit his own. Mr. Bernanke does.
These changes inside the Fed’s policy-making body, the Federal Open Market Committee, are manifestations of an important shift under way in the world’s most powerful economic institution. For years, the markets hung on every word of Mr. Greenspan. It was a sign of his dominance of the Fed, and his habit of embedding clues to the direction of interest rates in carefully crafted, often opaque speeches.
The new chairman is trying to depersonalize the Fed by making its decision-making more democratic and easier to understand. Mr. Bernanke, a 52-year-old former Princeton University economics professor, hopes he will one day be considered as successful as Mr. Greenspan and his predecessor, Paul Volcker. Yet Mr. Bernanke has long believed the Fed’s success depended too much on the “personal preference” of those two men, as he once wrote.
Mr. Bernanke “wants to associate monetary policy less with the chairman and more with the institution,” says Mark Gertler, a New York University economist and longtime Bernanke friend.
It’s a conviction born from Mr. Bernanke’s years as an academic, as well as a stint from 2002 to 2005 as a member of the Federal Reserve Board under Mr. Greenspan. Mr. Bernanke’s early struggles to communicate in his new job have reinforced his belief that markets hang too much on the Fed chairman’s choice of words. A comment he made in April, which he believed was misinterpreted, led some to question his anti-inflation resolve. His plan is for the Fed to be more clear about its goals and expectations for inflation and economic growth so the markets don’t react so much to his every utterance.
Enviable Record That will be challenging, in no small part because the Fed he inherited wasn’t in obvious need of improvement. Mr. Greenspan left an enviable record: strong growth, low inflation, and a near-sterling reputation with the public, politicians, markets and his colleagues. Since Mr. Bernanke took over, the confluence of slowing economic growth and rising inflation has made interest-rate decisions trickier than in the closing months of Mr. Greenspan’s reign.
In Mr. Bernanke’s view, making the Fed more “transparent” doesn’t mean talking more, but providing more systematic, specific information, in particular about the Fed’s goals — such as for the inflation rate — and forecasts. This, he believes, would have several benefits. If the Fed were clearer about the inflation rate it aimed to achieve, the public and companies would be less likely to press for higher wages and prices in anticipation of higher inflation. That would make it easier for the Fed to keep inflation low and stable, without wrenching changes in interest rates.
Publishing clearer and more frequent forecasts for growth, unemployment and inflation would also let the markets better anticipate the Fed’s interest-rate actions, Mr. Bernanke believes. This might mean markets would move less on the particular words in a Fed speech or statement. For example, stocks declined yesterday in part because Federal Reserve Bank of San Francisco president Janet Yellen said she was worried about wage pressure. Yet other analysts focused more on her observation that inflation may decline faster than generally expected.
Mr. Bernanke’s strategy carries risks. If the Fed’s forecasts are repeatedly wrong or if the Fed fails to meet its goals, its credibility will be undermined. The public may ignore the Fed’s pronouncements when making decisions about prices and wages. Additional information and opinions from the Fed could lead to more confusion, not less.
The Fed has long struggled with just how much to communicate. Past officials thought more information would make markets unnecessarily volatile, and limit the Fed’s ability to change course. Before 1994, the Fed didn’t even announce when it changed interest rates. Investors had to infer that action from how the Fed bought and sold securities in the markets. Mr. Volcker, long skeptical of the value of transparency, has said he liked to surprise the markets from time to time. Otherwise, investors became overconfident about rates and took on too much risk, he believed. “I liked a little constructive uncertainty,” he said at a conference earlier this year, according to the conference organizer, Grant’s Interest Rate Observer.
Mr. Greenspan, who took over in 1987, made the Fed more transparent in the latter part of his tenure, announcing rate actions and releasing a short statement on the day of its meetings, describing reasons for the action and where it thought growth and inflation were headed.
Still, he recognized there were limits. A central banker’s views on the economy and interest rates are always subject to uncertainty and caveats. Yet markets will often ignore the uncertainty and caveats and overreact. Mr. Greenspan countered the market’s inability to deal with nuance by speaking opaquely, or as he once put it, using language that “says less than it sounds.”
As other members of the Fed’s policy-making board are encouraged to speak out, it could lead to a more divergent group, leaving investors to wonder what the consensus is. Before, they could safely assume only Mr. Greenspan’s opinion really mattered.
Some experts say making the Fed more democratic simply isn’t compatible with the strong leadership the world expects from the U.S. central bank. “Like it or not, the institution has the ability to make markets move, and right, wrong or indifferent, you can’t have 12 presidents and six governors with credibility sending different messages to the market,” says Michael Belongia, a former adviser at the Federal Reserve Bank of St. Louis who now teaches economics at the University of Mississippi.
But Princeton economist Alan Blinder, who served as Fed vice chairman under Mr. Greenspan and is a friend of Mr. Bernanke, says the point of the new initiatives is to minimize the damage that can be done by one person. He cites the late Arthur Burns, who presided over a relentless rise in inflation during the 1970s. “Would I argue you’d get better policy than Alan Greenspan delivered? No. He was fabulous. But would you get a better policy than Arthur Burns delivered? Yes.”
Mr. Bernanke, the first academic to run the Fed since Mr. Burns, formed his views during his 17-year career as a professor of monetary economics at Princeton. There, he was one of the country’s leading advocates of setting a public target for inflation, an approach other countries have adopted.
The Bank of England, Britain’s counterpart to the Fed, is a Bernanke favorite. It has a public inflation target of 2%. Each quarter, the bank publishes a report showing the growth and inflation forecast of the nine-member Monetary Policy Committee and prospects for meeting the inflation target. That report draws far more attention from markets than speeches by the head of the Bank of England.
One of Mr. Bernanke’s early lessons is that market participants will try to read something about interest rates into almost anything he says. Mr. Greenspan accepted and catered to this, often planting a vague signal about rates in a speech or testimony. Former governor Laurence Meyer once said hunting for the key sentence in a Greenspan speech was like the children’s book, “Where’s Waldo,” where the reader must pick out Waldo from hundreds of faces.
In April, Mr. Bernanke told Congress’s Joint Economic Committee that even if it thought the risks between higher inflation and lower growth “are not entirely balanced, at some point in the future the [Federal Open Market] Committee may decide to take no action at one or more meetings in the interest of allowing more time to receive information relevant to the outlook.” This didn’t, he added, “preclude actions at subsequent meetings.”
Investors and reporters — accustomed to reacting to the subtle clues Mr. Greenspan planted in his speeches — thought Mr. Bernanke was signaling that the Fed, after raising rates a quarter of a percentage point for 15 straight meetings, would soon pause, and perhaps stop, in its rate increases.
Paul McCulley, an economist at Pacific Investment Management Co., a huge bond-fund-management company, in Newport Beach, Calif., says, “I thought he was giving a very articulate message very similar to Greenspan’s very famous ‘There will come a time’ statement of February 1995.” That’s a reference to when Mr. Greenspan, at the end of a string of rate increases, told Congress: “There may come a time when we hold our policy stance unchanged, or even ease, despite adverse price data, should we see signs that underlying forces are acting ultimately to reduce inflation pressures.” The Fed cut rates less than five months later.
After Mr. Bernanke’s remarks in April, Pimco and others began positioning for a halt in rate increases; bond yields fell and stocks rose.
But as markets began to price in fewer Fed rate increases, they also priced in higher expected inflation. This troubled Mr. Bernanke, who has been dogged by suspicions that he is soft on inflation. A few days after his testimony, CNBC news anchor Maria Bartiromo reported that Mr. Bernanke told her at the White House Correspondents’ Association dinner in Washington that the markets misinterpreted his testimony — that a pause didn’t necessarily mean a halt, and he was not soft on inflation. Stocks and bonds retreated.
The unorthodox way in which Mr. Bernanke’s views became public surprised traders. Mr. Bernanke quickly recognized the potential damage of the incident. The next morning, at a scheduled meeting with a Wall Street bond advisory group, he said it was his intention to communicate through formal channels, and the Bartiromo incident was “not a good example of that,” according to people in attendance. At a dinner for a retiring colleague shortly afterward, he made light of the incident. The annual correspondents’ dinner, he said, “as you all know, is one of my favorite events.”
Crossed signals continued to dog Mr. Bernanke. In June, he proposed a meeting with representatives of the Bond Market Association, a Wall Street trade group, to discuss technical bond-market matters. The association set up a meeting between Mr. Bernanke, another governor and a group of bond traders.
When some bond traders tried to elicit clues on interest rates, Mr. Bernanke wouldn’t bite, these people said. Nonetheless, rumors circulated the next day that he had raised the possibility of a half-percentage-point rate increase, prompting some analysts to complain the Fed was overreacting.
Mr. McCulley, the fund manager, says in retrospect that he read Mr. Bernanke’s testimony too much through the filter of what Mr. Greenspan had said 11 years before. Interpreting the Fed chairman now, he says, will require reading his entire speech rather than just one paragraph, and paying more attention to his discussion of the forecast and his goals. He expects “Greenspan-style sound bites will move to the back burner.”
In recent months, markets have signaled greater confidence in Mr. Bernanke: Their expectations of inflation have declined, aided by a tame reading on consumer prices and rapid softening in the housing market.
Problems communicating the Fed’s views this year have strengthened the case for transparency, Fed officials believe. Earlier this year, Mr. Bernanke appointed Vice Chairman Donald Kohn to head a committee on communications. It is expected to consider, among other things, naming an inflation target or “objective,” and issuing forecasts four times a year instead of twice.
To do that, officials will have to answer some difficult questions. For example, whose forecast should the Fed release? Would they have to collectively agree on a single forecast? The forecast currently released twice a year to Congress is a range of many, often inconsistent, views. And if the Fed chooses an inflation target, what number, or range of numbers, and price index should it use, and over what time period?
In recent years, FOMC policy discussions had become somewhat scripted. Mr. Greenspan’s views usually preordained the outcome. The critical statement released at the end of every FOMC meeting — disclosing the interest rate action, with a brief description of the group’s economic outlook — was increasingly drafted prior to the meeting.
Trying to shake this up, Mr. Bernanke, in addition to speaking last instead of first, has allowed more changes to the statement to be made during the meeting. He encourages members to speak out of turn in order to respond briefly to another’s remarks. For permission to do so, they must raise two hands, a gesture dubbed a “two-handed intervention.”
“It’s a way of having a more complete dialogue and it’s successful,” says Federal Reserve Bank of St. Louis President William Poole.
A truly democratic Fed could reduce Mr. Bernanke’s role to one vote, much like the chief justice of the Supreme Court. That hasn’t happened. Fed insiders say Mr. Bernanke leads and shapes debates at meetings. Moreover, not all his colleagues’ views carry the same weight. He turns in particular to the Vice Chairman Mr. Kohn and Federal Reserve Bank of New York President Timothy Geithner for advice and feedback.
Mr. Bernanke has also cultivated the Fed’s professional staff, the core of which is more than 200 Ph.D. economists. Mr. Greenspan thought highly of the staff but kept most at arm’s length, preferring memos to meetings except when a staffer was working on a special project for him. Mr. Bernanke often sits down with junior economists for lunch in the staff cafeteria to learn about their research or discuss baseball. He’s a regular at Washington Nationals games.
While Mr. Greenspan played tennis on the Fed’s courts with Washington power brokers, Mr. Bernanke plays pickup basketball with the junior staff. He occasionally can be found shooting baskets alone on the Fed’s court.