Federal Reserve officials have grown increasingly unhappy with the impact on financial markets of their new effort to inform the public whenever they change their view about the likelihood of near-term changes in interest rates, according to the minutes of an Oct. 5 policymaking session released today.
At that meeting, members of the policymaking group, the Federal Open Market Committee, took no action on rates but adopted a directive that was "biased" toward higher rates. That decision sparked a discussion about what has happened since the FOMC agreed at the end of last year to begin announcing such moves immediately. In the past, the adoption of a "biased" directive was disclosed only when the minutes of a meeting were released six to eight weeks later, so market participants usually paid relatively little attention to it.
This May was the first time the FOMC adopted a bias toward raising rates and announced it right away. Financial market participants reacted to the announcement, to the dismay of many of the committee members, virtually as if rates had been increased.
At the next meeting, at the end of June, the target for overnight rates was raised and the committee went back to a neutral directive--not because another rate increase wasn't likely but because the members feared that that if they said that they were still leaning toward higher rates, the market would overreact again.
At the Oct. 5 meeting, FOMC "members observed that the recent practice of making such announcements had led to some misinterpretations of the committee's intentions and seemed to have added to volatility in financial markets," the minutes said.
"As a consequence, committee members briefly considered alternative treatments of symmetry [that is, whether the directive has a bias or not] and disclosure for this meeting. Because the committee had begun a process for examining the wording of its directive and its announcement policy, most of the members concluded that the most satisfactory alternative for now, though it was not fully satisfactory, was to continue with the committee's recent announcement practice," the minutes said.
In August, Fed Chairman Alan Greenspan created a working group of FOMC members headed by Fed Vice Chairman Roger W. Ferguson Jr. to thrash out a different approach and report back by next spring. Last month, the working group "was requested to expedite its report," the minutes said.
At the FOMC meeting held Tuesday, the committee raised its target for overnight interest rates by a quarter-percentage point, to 5.5 percent, and dropped the bias in its directive, with both actions immediately made public. The issue of announcing changes in the bias undoubtedly came up again but evidently was not resolved because it is expected that any new policy will itself be announced whenever it is agreed upon.
One key problem, according to several FOMC participants, is that financial markets don't know very precisely what having a biased directive really means--and that to a large degree is because there is no agreement among the committee members about what it means.
Some participants regard a biased directive as applying only to the six- to eight-week period until the next meeting. Others see it as an indicator of possible future policy actions up to and beyond the subsequent meeting.
While it hasn't happened this year, in the past there have been long stretches in which the FOMC has adopted a biased directive at meeting after meeting and then moved back to a neutral position without actually changing rates.
The major value of a biased directive for the FOMC has been its use in helping achieve a consensus among the members. For instance, if some members wanted to raise rates but a majority did not, formally adopting a bias in that direction often persuaded the members favoring higher rates to vote with the majority.
Under those circumstances, the FOMC could use the bias without necessarily ever agreeing on exactly what it meant. Now the group is faced with coming up with a consensus on exactly what it means, which is a formidable task.
A few members have said privately that they would like to drop use of the bias altogether and just make an announcement after each FOMC meeting to convey the committee's views to the public. Other members believe the bias is still a useful device and all that is needed is to find a better way to communicate its meaning to the public.
CAPTION: Fed Chairman Alan Greenspan, shown arriving for Tuesday's policymaking meeting, has created a group to weigh alternatives to "biased" directives.