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Fed policy foggy as the economic picture clouds

Chairman Ben Bernanke faces pressure to make the Fed's message more lucid.
Chairman Ben Bernanke faces pressure to make the Fed's message more lucid. (Joshua Roberts)

And since the Fed decided Aug. 10 to take the modest step of buying more assets to replace those on its balance sheet that mature, neither Bernanke nor those who are closest to him - such as New York Fed President William C. Dudley and governors Donald L. Kohn and Kevin M. Warsh - have made a public appearance to explain the rationale for the move or indicate the likelihood of more aggressive steps to support growth.

Instead, market participants have heard from Minneapolis Fed President Narayana Kocherlakota, the newest policymaker on the committee, who said the Fed's decision "had a larger impact on financial markets than I would have anticipated."

Rather than criticize or call out colleagues for bringing the Fed's internal debates into the public sphere, Bernanke has subtly encouraged this airing of opinions, praising points that some of his colleagues have made in Federal Open Market Committee meetings or private e-mails.

But the question now is whether he can corral people with disparate views into making a coherent monetary policy.

"It's Bernanke's leadership style, and it has been since Day One, to encourage transparency and open debate," said Diane Swonk, chief economist at Mesirow Financial. "That's a good thing in general, but right now, while we're not sure where policy is going, it brings confusion to financial markets rather than clarity."

Part of the challenge Bernanke faces in his speech Friday, to be delivered at the Kansas City Fed's annual economic symposium taking place at Grand Teton National Park, is to reassert leadership even as he cannot be too precise about the course of Fed policy, Fed watchers said.

Fed leaders view the slowing pace of recovery as disturbing, but hold to the view that continued expansion is more likely than a dip back into recession. If economic growth slows significantly, the Fed would consider large new purchases of Treasury bonds and mortgage-backed securities, to the tune of hundreds of billions of dollars, a strategy that is known as quantitative easing.

But it is an open question how much impact such a move would have on growth, given that interest rates are already very low. Several members of the Fed policymaking committee, including Hoenig and Plosser, are likely to be strongly opposed to any such move.

People involved in financial markets will read Bernanke's speech closely for evidence of what the Fed's "reaction function" is. In other words, how much worse would the economy have to get before a new bond purchase program was undertaken?

More than anything, they will be looking for signs that there is a plan and that the Fed can move decisively if necessary.

"He needs to overcome this idea that the Fed is paralyzed, either because they don't have the tools to succeed or because they don't all agree," said Ethan Harris, the Bank of America-Merrill Lynch economist.

"He will need to admit the recent weakness in the data, justify the action they took at the last meeting, yet not be alarmist and sound desperate. That balancing act will be tough."

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