Officials in economies large and small face a similar dilemma. Suppressing inflation without triggering a serious slowdown is a tricky task at the best of times – and this is far from an ideal moment. Inflation has proved more damaging than forecast. Where policymakers really stumble is when they signal early or say openly what their next steps will be. Central banks then find themselves at the last minute to reset expectations – which they created themselves – if inflation behaves badly. No wonder the markets are unnerved. Did central banks inadvertently create a beast they can’t really control now?
Just think of all the excitement this week. The Fed raised interest rates by 75 basis points on Wednesday, a larger step than expected a few days ago. Hours earlier, the European Central Bank called an emergency meeting of its Governing Council – the scheduled conclave took place just last week – to announce that it was accelerating work on a tool to combat a rise in bond yields. On Tuesday, the head of the Reserve Bank of Australia went on TV for a rare prime-time interview in which he signaled a period of significant interest rate hikes was imminent. Governor Philip Lowe stressed last month that quarter-point moves were “business as usual.” Also, prepare for impromptu hikes in emerging markets; Indonesia and Thailand seem to be the best candidates.
The question now is whether today’s finance chiefs dare forego some of the transparency they have accustomed the public to – a practice that would have appalled their predecessors, who preferred to speak in codes and generalities. Forward guidance, the art of telling people what you’re likely to do with the price of money before you do it, worked when interest rates were around zero and inflation was quiet. This is clearly failing now.
After the Federal Open Market Committee meeting in May, Powell indicated that moves of 50 basis points were his preference. He reiterated that expectation in several interviews, so it seemed like a reasonable bet. However, it wasn’t until news articles on Monday that the Fed signaled that 75 basis points was more likely. Stocks plummeted and bonds fell around the world. In his press briefing Wednesday, Powell said the next hike would likely be either another 75 basis point hike or a return to May’s half-point rise. Although he has given himself more leeway, this can still end up being too specific. Markets rallied, but who says volatility won’t resume? We saw the serious flaws in forward guidance play out in real time this week.
For the Forward Guidance to be credible today, as it was for much of the previous decade, a few key ingredients are needed. The first is a clear message. That might sound obvious enough, but it gets harder as officials get more specific. People hear a number — say 50 basis points, or an inflation or employment threshold required for a rate change — and latch on to it, ignoring the qualifiers associated with it.
Another requirement is that the economy is in a state that allows for leadership with a degree of confidence. As Bernanke elevated forward guidance to something approaching an art form – a development welcomed and encouraged by his successors at the Fed and policymakers around the world – what seemed a sluggish but protracted recovery from the 2007- to be a reasonable scenario in 2009; Inflation seemed contained. The world was somewhat predictable, although it might not have looked like smooth sailing at the time. The last few years have been anything but easy to predict, thanks to the pandemic, the steep and short recession that followed the arrival of Covid, the rapid setback and accompanying surge in inflation. The best days of forward guidance may be behind her.
Bernanke addressed some of these difficulties when he started a blog at Washington’s Brookings Institution in 2015, a year after leaving the Fed. “Of course, the downside for policymakers is that the cost of sending the wrong message can be high,” he wrote. “That’s probably why my predecessor, Alan Greenspan, once told a Senate committee that as a central banker he had ‘learned to mutter with great incoherence.'”
Even Greenspan, for all its famous opaqueness, has set central banking on the path to greater openness. In 1994, the FOMC began issuing written comments on its interest rate decisions. While this seems like a no-brainer today, it was revolutionary back then. Greenspan began to realize that communications, if used selectively and at the right time, could be a powerful tool to manage expectations about how interest rates and the economy would develop. Just not too much, mind you. Forward Guidance has put communications on steroids – and markets on an IV drip. While reducing some of the excess will no doubt be met with howls, it might just return some power to officials. Despite all the tools at their disposal, central bankers appear to be prisoners of their own pronouncements and projections. Time to regain some control. More from the Bloomberg Opinion:
• Delayed start of inflation puts Powell in a dilemma: Jonathan Levin
• The Fed’s narrow path between inflation and recession: editorial
• Are central bankers telling us too much?: Daniel Moss
This column does not necessarily represent the opinion of the editors or of Bloomberg LP and its owners.
Daniel Moss is a Bloomberg Opinion columnist covering Asian economies. Previously, he was Editor-in-Chief for Economics at Bloomberg News.
For more stories like this, visit bloomberg.com/opinion