'Transparent' Won't Always Mean Clear at Bernanke's Fed
Sunday, November 27, 2005
If the next chairman of the Federal Reserve, Ben S. Bernanke, succeeds in making the Fed more "transparent," imagine how life might change for investors.
Gone might be a lot of the guesswork involved in deciding when to buy bonds or bond mutual funds. Less frequent might be the squalls of volatility that so often hit stock and bond prices whenever Fed policymakers meet.
Fewer, just possibly, might be the number of people employed on Wall Street in Fed-watching and related jobs.
At this stage, it's far from obvious how much can be done to take the mystery out of the Fed's intentions in regard to the economy, interest rates and such. Clarity in communications seldom comes easily, even on subjects much simpler than this one.
And there is always a risk that more openness at the Fed could backfire and produce more minute-by-minute volatility in the markets, not less.
Still, Bernanke, who takes over the helm at the Fed early next year when Alan Greenspan retires, says he means to try.
"Under Chairman Greenspan, monetary policy has become increasingly transparent to the public and the financial markets, a trend that I strongly support," Bernanke told a Senate committee last week as he coasted through a confirmation hearing.
"A more transparent policy process increases democratic accountability, promotes constructive dialogue between policymakers and informed outsiders, reduces uncertainty in financial markets, and helps to anchor the public's expectation of long-run inflation, which promotes economic growth and stability," he said.
Positive effects are easy to envision. The more confident people are about matters such as the inflation outlook, the more readily they may commit themselves to starting or expanding businesses, hiring workers, or lending or investing their money.
Should I buy a home, for example, using an adjustable-rate mortgage? The deal is much easier to decide upon if I think I can reasonably anticipate where interest rates are headed.
From market participants' point of view, however, the prospect raises unsettling questions as well. Bond and currency traders, in particular, make a living off uncertainty about what the Fed is up to. It stands to reason that reduced uncertainty might also mean reduced inefficiencies for them to exploit.
Tough luck, you may say -- hedge fund managers and other short-term traders make poor candidates for sympathy. The question remains, though, what sort of ripple effects we might get with less fractious markets.
How does greater transparency affect the vital function of "price discovery" -- the give and take in the market that sets interest rates? If traders take fewer risks in the markets, does risk migrate somehow to other places in the economy, to other people less eager to face it?
All of this conjecture may be moot, since there is probably no way to eliminate the confusion that naturally surrounds monetary policy. The chief communication tools available are words and numbers, and experience shows that both of these can be very clumsy implements.
On hearing the same set of words from Greenspan, different financial economists, market analysts and journalists regularly come to opposite conclusions about what was said and what it means.
It is customary to chastise Greenspan for intentional obscurantism. There is an alternative view: that he chooses his words so cautiously because he has seen over and over how susceptible they are to misinterpretation.
For a test case of how much transparency Bernanke may find within his reach, let's look at how he defined what he wants to accomplish. From his testimony: "Monetary policy is most effective when it is as coherent, consistent and predictable as possible, while at all times leaving full scope for flexibility and the use of judgment as conditions may require."
One reader may see that as a plain-spoken commitment, another as doublespeak. To me, it says Bernanke, while he may lay out stated goals such as target rates of inflation, carefully reserves the right to change his mind at any time.
Under such a regime, significant progress toward transparency may be possible in relative terms -- relative, that is, to the way things used to be. But transparency in any absolute sense? There is very little prospect of eliminating all uncertainty, confusion or disagreement about what the Fed is likely to do next.