Federal Reserve Chairman Jerome Powell is on a mission – a mission to guide the U.S. economy toward its longest expansion on record, and to help you understand how the central bank is going to do it.
There’s just one problem: Being easier to understand opens itself up to a new set of risks.
That’s a lesson Powell has been forced to confront, since he took the helm at the Fed more than a year ago. The U.S. central bank’s objectives can often be mind-bendingly complex, and as Powell attempts to communicate in a way that non-specialists can understand, he’s stirred up some market choppiness.
First there was his appearance at an October public affairs conference in Washington. Powell described interest rates as “a long way from neutral,” after which global bond markets and the S&P 500 tanked.
That happened again during the Fed’s December post-meeting press conference, when Powell said the Fed was on “automatic autopilot” when trimming its balance sheet. Investors took it as an unsettlingly aggressive message, and those jitters helped send stocks to their worst December since the Great Depression.
Even more recently, the picture hasn’t changed. Markets were turbulent after the Fed’s May news conference, when Powell called the forces holding down inflation “transitory.”
Oversimplification – “that’s the risk,” says Bill English, finance professor at the Yale School of Management who worked at the board of governors for more than 20 years. “You try to make sure that folks do understand what the committee’s intentions are and what its approach is, but you’re never going to get communications entirely right.”
The Fed could soon bring this conundrum up, as it gears up for its long-awaited review session of its strategies, tools and communication practices – set for Tuesday and Wednesday. During the conference, a session will cover Fed communication, and a working research paper published in advance calls upon officials to communicate more simply, though it recognizes that the markets might not always cheer the message.
“One of your audiences is the public and another audience is the financial markets, and a lot of people in the financial markets do know the economists’ language. But when you talk to the public, you might be losing a bit of the precision that they want to hear in the markets,” says Narayana Kocherlakota, economics professor at the University of Rochester who formerly served as the president of the regional Minneapolis Fed. “That’s a tension you face. In the short run, there might be some glitches.”
Powell’s plain speak marks shift in Fed’s ‘philosophy’
One February evening, an event at the Fed provided a window into this new initiative. In the room where interest rate decisions are made, Powell took questions from educators across the nation regarding what the Fed does and does not do.
“Federal Reserve policy affects everyone, and we need to work hard – and we do work hard – at trying to communicate in a way that doesn’t lapse into economic jargon, so it can be understood by anyone who’s interested,” Powell said. “In my speeches, I try to deal with the most challenging, most important, economic issues without using jargon in a way that can be understood by the interested public, without dumbing anything down.”
It marks a shift from former Fed chairs, including the notoriously cryptical Alan Greenspan, who reportedly once said: “If I turn out to be particularly clear, you’ve probably misunderstood what I’ve said.”
“There’s been a change in the philosophy of the organization,” Kocherlakota says. “The Fed being clear about what it’s trying to do, its actions, those key objectives – they give the public more confidence in those objectives being achieved in the future. That’s helpful for monetary policy always.”
Even after just over a year in the role, Powell has made significant changes to the way the rate-setting committee communicates. Not only has he stressed the value of “plain speak,” but he’s also led the Fed toward hosting press conferences after each rate-setting meeting. Those were previously held once a quarter, with the first under Bernanke in 2011, in the wake of the financial crisis.
Fed watchers are also accustomed to receiving records of the Fed’s policy meetings three weeks after each rate decision. Those, however, weren’t first made public until 1993, and at that time, they were released three days after the subsequent meeting. A year later, the first form of a post-meeting statement was published, and so was a public target for the federal funds rate.
The number of times officials speak to the public between meetings has also increased. Public remarks between the years of 1998 and 2005 totaled at around 150, according to a St. Louis Fed analysis. In 2013, however, that number reached 220. So far this year, almost halfway through the year, there have been 150 appearances.
Among Fed presidents, there were 60 days in 2017 when more than one spoke publicly, compared to about half of that number in 2004, the St. Louis Fed also found.
“The Fed has been in a long transition for the last 25 years. They’re feeling that if monetary policy is better communicated, it will be more effective,” says Jonathan Wright, economics professor at Johns Hopkins University. “If people understand what they are trying to accomplish, why they are moving interest rates, and where they will go in the future, the Fed will, in turn, have more leverage.”
Fed communication aids credibility, transparency
That leverage has a lot to do with the curious concept of inflation expectations, or the theory that price pressures are heavily influenced by where the public thinks it will be in the future.
It goes like this: If consumers expect inflation to skyrocket, drastically reducing their purchasing power, they might decide to start buying items and making their financial decisions right away. Businesses will likely do the same. It’s also believed that workers might start to demand higher pay — fearing that the impending price pressures could eat away at their incomes. Those reactions create the inflation that was feared all along.
But if the public has faith in the central bank, they won’t react like this if inflation starts to rise. That’s what economists mean when they say “inflation expectations are well-anchored.”
Communication also gives the Fed more influence over long-term rates and asset prices, Wright says. The federal funds rate is the central bank’s direct tool for stimulating or stabilizing the economy, but it’s a short-term rate. Mortgage rates, for example, aren’t directly impacted by any hikes or cuts.
“The Fed is trying to control or influence this whole constellation of asset prices and interest rates, and all it actually directly gets to control is the overnight federal funds rate,” Wright says. “If all you’re going to do is work with the federal funds rate, once you’re at zero, you’re done. However, if you signal that you’re going to keep rates at zero for a long time, then you can continue to ease financial conditions.”
Recession, presidential backlash makes Fed communication more important
But today, this effort to communicate more clearly is part of a move to provide more transparency, Wright says. In a world where President Trump has no qualms about expressing where he’d like to see interest rates go, Powell has to confirm that him and his colleagues aren’t bending to political pressure.
That could be why the Fed felt it necessary to disclose that Powell and Vice Chair Clarida met with the president over dinner in early February.
“With any previous president or administration, you wouldn’t have been getting the public criticism of monetary policy that would think it necessary to release a statement like that,” Wright says. “I’ve never known another case in a developed country where the communication strategy is, among other things, reminding markets of the independence of the central bank.”
But the Fed’s communication might have evolved simply because that’s what Powell is used to. Powell is the first chair in 31 years who doesn’t hold a Ph.D. in economics. He previously worked as an investment banker and holds a law degree from Georgetown University.
“We think we’re being clear, and you’re just not being as clear as you think you are. There’s a tendency to lapse into the jargon of your profession,” Kocherlakota says. “Chairman Powell doesn’t come with that baggage,” he’s most likely thinking “I’m going to talk about it in the way that I understand it, and that’s been great at making the Fed more accessible.”
Easy-to-understand message gives ‘great scope’ for accidents
Powell isn’t the first Fed chair to make a blunder. In her first news conference, Janet Yellen tanked markets by being too specific about when the Fed would next raise interest rates.
“This is the kind of term it’s hard to define, but, you know, it probably means something on the order of around six months or that type of thing,” Yellen said at the Fed’s March meeting in 2014.
Wright, however, can’t think of a time when Greenspan caused such a reaction, “precisely because he was so cryptic. He never put himself in the position of having to do a press conference,” he says. “This is one of the downsides of greater transparency. Chairmen are humans. You’re going to be at risk of a slight misstatement. There’s great scope for accidents.”
Current economic conditions have illustrated that phenomenon. Unemployment and inflation are low, and the fundamentals still look strong, but Fed officials are facing a myriad of uncertainties, from trade and Brexit to slowing global growth. An overly hawkish message could spook markets, but an overly dovish message could lead investors into thinking a cut is imminent.
And many already are. Five months into the Fed’s monetary policy U-turn, markets have continued to prove that what they hear isn’t always what central bankers say. As the Fed preaches patience, investors have instead heard the word “cut.” Federal funds rate futures show that investors are pricing in a 98 percent chance that the Fed would knock down its short-term interest rates in December, up from 47 percent a month ago, according to CME Group.
“Over the last six to eight months, the economic outlook has been especially hard to communicate about,” English says. “They’re telling this story basically that the economy is doing well, but we’re worried. Part of the difficulty of communication is trying to get the balance right.”
It’s hard telling what could come out of the Fed’s review session. Powell has stressed that the outcome of this meeting will more likely be an evolution, not a revolution, and official decisions won’t be made public until next year.
Those improved economic conditions, however, might mean the Fed has room to stop guiding the markets so much. That’s led Wright to personally believe officials should decide to shelve their so-called “dot plot.”
“As long as they keep the dot plots, a pretty explicit kind of forward guidance is hardwired into the monetary policy process,” he says. “Although transparency in general is good, it can go too far.”
But until then, there’s likely more choppiness ahead. When markets are turbulent, it’s hard to remain calm, but that’s what’s most important. Ignore the hype and focus on the long-term message, rather than analyzing every word that a Fed official says, says Greg McBride, CFA, Bankrate’s chief financial analyst.
“There is an obsessive nature of markets parsing every word from the Fed in an effort for a short-term trading edge, and that is just the kind of nonsense consumers and individual investors need to stay away from,” McBride says. “Focus on the bigger picture — the health of the economy, actual changes in interest rates, and what opportunities that creates from the investment and debt perspectives.”
Even though it’s common for markets to overreact to statements when they’re simpler to understand, communicating with the general public has its advantages.
“It’s important for the central bank not to be seen as a tool of Wall Street,” Kocherlakota says. “Having the chairman speak in plain language, so that the public can understand why the Fed is doing what it’s doing, it helps to build the kind of support and understanding of what the central bank is about. Parsing particular words and sentences like ‘a long way from neutral’ — sometimes investors overreact to little things like that. But more big picture, that’s a trade off the Fed should be willing to make.”