Fed communication and the Maradona theory of interest rates
“If I seem unduly clear to you, you must have misunderstood what I said.” – Alan Greenspan speaking to a Senate Committee in 1987 ||
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Fed communication and the Maradona theory of interest rates
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WHAT I’M WATCHING:
Fed communication and the Maradona theory of interest rates
There are task forces, and there are task forces.
As you know, Fed Chair Kevin Warsh has set up a few of these to re-examine how the US central bank should do its job. There’s one on data, another on the Fed’s balance sheet, one on inflation frameworks, on the impact of AI on productivity and jobs… but arguably the most consequential for markets is the task force on communication.
Since markets price in likely future Fed actions, expectations matter. These are inevitably going to be influenced by communication from the central bank, whether deliberate or inadvertent – when deliberate, it can be used as a market lever. What’s more, consensus around expectations is likely to contribute to market stability. So, for the past couple of decades, we’ve gotten used to “forward guidance”, in which the Federal Reserve lets us know what it expects interest rates to be going forward. It guides the market’s expectations.
The new Fed Chair has made clear he would like to do away with forward guidance. He believes it locks in forecasts and slows central bank action when conditions change; that it should not be necessary outside of crises; and that the Fed should be taking signals from the market rather than the other way around.
Other officials have gone further, accusing journalists of being too lazy to analyse monetary policy on their own (not a journalist’s job, but whatever).
In sum, Fed communication is important, and it’s going to change.
To get an idea of what that might look like, I turned to the head of the communications task force Lord Mervyn King, former governor of the Bank of England and author of easily the best book I have read to date on the philosophy of finance – The End of Alchemy: Money, Banking and the Future of the Global Economy, published in 2016.
Given its renewed relevance, I pulled it off the shelf to see what Lord King has to say about how central banks should interact with the public.
To sum up his view in two words: they shouldn’t.
When King joined the Bank of England in 1991, he asked Paul Volcker for advice. Volcker was succinct: “mystique”.
