Not so long ago, the Federal Reserve tried to obscure its operations behind a fog of jargon and euphemisms. As Beltway legend has it, when a senator told Alan Greenspan that he understood one of his points, the longtime Fed chairman replied, “Then I must have misspoken.”
Greenspan’s successor, Ben Bernanke, has pushed the central bank and its members to be more direct. Bernanke held the Fed’s first-ever press conference in 2011, and in his testimony to Congress he’s tried to demystify the bank’s extraordinary efforts to boost the economy, which currently take the form of buying $85 billion of bonds each month and keeping short-term rates near zero. It was at one of those hearings, in May, that Bernanke first talked about the possibility that the purchases could wind down sooner than expected. The reaction was violent: Stocks, bonds, gold, and other assets sold off sharply at the prospect of the Fed’s fuel drying up, and a key measure of volatility surged 44 percent.
Bernanke and his central bank colleagues took to podiums and airwaves to calm the markets with comforting everyday imagery. Or tried to. “To use the analogy of driving an automobile,” Bernanke said in a prepared statement on June 19, “any slowing in the pace of purchases will be akin to letting up a bit on the gas pedal as the car picks up speed, not to beginning to apply the brakes.” Bernanke set the standard for muddled metaphors when he parried reporters’ questions that day. Certain economic data, he said, “are guideposts that tell you how we’re going to be shifting the mix of our tools as we try to land this ship on a, you know, on a—in a smooth way onto the aircraft carrier.”
When that didn’t help—stocks and bonds plummeted even further—a second Fed official suggested the situation was really more like smoking. “It seems to me the chairman said we’ll use the patch—and use it flexibly—and some in the markets reacted as if he said ‘cold turkey,’ ” said Atlanta Fed President Dennis Lockhart.
A third official, Richmond Fed President Jeffrey Lacker, conjured a boozy party: “The Federal Reserve is not only leaving the punch bowl in place, we’re continuing to spike the punch.” That’s because the economy is “in a tug of war,” a fourth Fed executive said. A fifth steered things back to the highway: “If we were in a car, you might say we’re motoring along, but well under the speed limit.” That’s despite, as a sixth said, the biggest investors acting “somewhat like feral hogs.” Well, that clears things up.
Stocks have recouped much of their losses since the chairman’s original comments, but yields on benchmark 10-year Treasuries remain near their highest level since August 2011. (Bond yields rise when prices fall.) “I’m not in general a big fan of these analogies or metaphors or whatever they are,” says Dean Maki, chief U.S. economist at Barclays (BCS). “At times they oversimplify.”
Other economists give Bernanke higher marks. “You’re dealing with something that has never been done before,” says Jeremy Siegel, a Wharton School professor of finance, referring to the unprecedented scope of the Fed’s stimulus. “The more analogies you can make that help people conceptualize what is happening, the better.”
The episode recalls a famous line from Cool Hand Luke, says Drew Matus, a senior economist at UBS (UBS): “What we’ve got here is failure to communicate.” The breakdown, Matus says, may reflect a disagreement about how the Fed’s asset purchases have been stimulating markets. Bernanke says that it’s the $3.5 trillion size of the bank’s balance sheet that matters: Investors can’t buy that stuff while the Fed’s got it, and that increases the value of other assets on the market. Many traders counter that it’s the monthly flow of purchases that matters, which helps explain why just talking about a reduction jolted stock prices and bond yields so much. “The fact is that the Fed speaks a different language than we do,” Matus says. “Wall Street tries pretty hard to understand what the Fed means, for obvious purposes. And we have a fundamental disconnect, in that no one in the markets believes” the balance sheet theory.
Now a new source of confusion looms: Economists forecast that unemployment will fall to around 7 percent—the level Bernanke has targeted—in the fourth quarter of this year, significantly before mid-2014, when the chairman has suggested the purchases will stop. “It will definitely pose more communication problems for the Fed,” says Matus. “And once again, those problems will be of its own making.”
Economist Paul Krugman and other commentators have noted that with the Fed sending mixed signals, traders are listening more to the tone of Fed utterances than their substance, giving the folksy similes all the more influence.
“The exit will take years,” says Darrell Duffie, a finance professor at Stanford’s graduate business school. “The Fed will be as precise as it believes it can be, in light of its own uncertainty. They don’t have a crystal ball, and they don’t want to say, ‘We’re going to do exactly this at this time.’ Because of that, they’re going to have to talk the market through it as they go.”