Is it possible to be too transparent?
That’s the question the Federal Reserve will be grappling with this week when its top officials meet in Washington for their regular policy-setting meeting. Transparency has been the mantra of the central bank since former Fed Chairman Ben S. Bernanke took the helm of the historically secretive institution in 2006. He has cited changing that mindset as one of his greatest achievements.
But officials may realize that less could be more when it comes to the Fed’s official guidance on when it will raise interest rates. The central bank has gone through several iterations of its promise to keep its benchmark short-term rate at zero over the past five years, each one more definitive than the last. Most recently, it vowed not to raise rates at least as long as the unemployment rate was above 6.5 percent.
That explicit commitment helped convince Wall Street that the Fed meant what it said. But the jobless rate fell more quickly than officials expected. It’s now at 6.7 percent and flirting with the Fed’s threshold, leaving officials once again searching for the right words to reassure markets.
One thing seems clear: The threshold will be swept away. Deciding what to replace it with is the hard part.
It’s unlikely that the Fed will opt for a single statistic again. The unemployment rate turned out to be an insufficient measure of the health of the labor market. Many economists believe it has fallen largely because the workforce is shrinking -- baby boomers retiring, millenials staying in school longer and the unemployed giving up hope of finding a job. Fed Chair Janet Yellen has cited at least four alternative indicators she uses to take the pulse of the job market; officials at the Bank of England released a list of 18.
The Fed’s communication conundrum underscores a broader point: It’s much easier to explain what a healthy economy isn’t than what it is. In other words, almost everyone can agree that an economy in which the unemployment rate is above 6.5 percent pretty much stinks and interest rates should remain at zero. But below that point, there’s a lot more uncertainty about how far the Fed should go.
“Markets like the idea that there was a single measure [the unemployment rate] for them to look at,” said David Stockton, the Fed’s former chief economist and now a senior fellow at the Peterson Institute for International Economics. “They want the Fed to tell them when they’re going to change interest rates. The Fed can’t really do that because they don’t really know how the economy is going to evolve”
San Francisco Fed President John Williams and Atlanta Fed President Dennis Lockhart have both said that the first rate hike should come when the jobless rate is about 6 percent. Williams in particular warned about the dangers of the Fed getting too close to the economy’s natural rate of unemployment. But Minneapolis Fed President Narayana Kocherlakota believes no move should be made until the jobless rate falls to at least 5.5 percent. Others think the Fed’s policies are breeding instability in the financial system and that rates should be hiked as soon as possible.
What do public officials do when they’re not really sure of something? Say as little as possible. Instead of “quantitative” guidance that relies on a single number of set of statistics, several key officials have been pushing for a “qualitative” description of the economic conditions that would justify a rate hike.
“They want to be vague, right? That’s what qualitative means,” said Roberto Perli, head of global monetary policy research at Cornerstone Macro. “They don’t want to be too precise. I think the reason is that the economy is approaching some sort of inflection point … They don’t want to tie their hands.”
If you’re thinking this strategy sounds familiar, you would be right. The Fed used the phrase “substantial improvement in the outlook for the labor market” as the guidepost for ending its $1 trillion-and-counting bond-buying program. (And if you’re also thinking that markets were confused by that language -- and that the Fed exacerbated the problem -- you would also be right.)
“Trying too hard to explain can be counter-productive,” said Mark Olson, chairman of Treliant Risk Advisors and a former Fed governor.
The trouble is that investors and the public have come to expect nothing less than full disclosure. But the limit to Fed transparency may be its own uncertainty about the right path for policy. Here’s the real truth: Fed officials aren’t exactly sure when the right moment to raise rates will be. And that may be the clearest answer they can give.