Fed Officials Are a Bunch of Oversharers
Not too long ago, Federal Reserve Bank of Minneapolis President Neel Kashkari conducted an "ask me anything" session on Twitter where we learned that his favorite soda is Cherry Coke Zero. Kashkari then enlightened the world to his rationale for dissenting on an interest-rate increase at the last meeting of the Federal Open Market Committee by posting a 3,600-word defense of his decision on the social media web site Medium.
When Fed officials are doing Twitter AMAs the central bank has finally achieved its goal of transparency, although I have never seen a compelling economic rationale for transparency in the first place, other than that the Fed is terrified of being audited. The logic goes that the Fed is a public institution, therefore it should be transparent. We want governments to be open, so why not the Fed, too?
I can think of some good reasons why we would want the Fed to operate in semi-secrecy. I was a trader, and the first thing you learn is that Fed decisions have more impact when they are a surprise. Surprises aren’t always good, but that’s kind of the point of a surprise. If you’re a Fed official, what you should care about is that your policies have the most impact. Paul Volcker certainly had impact. One of my former colleagues referred to him as “the idiot in the shower,” jerking the handle on the faucet back and forth, unable to find the right temperature. Maybe, but he was effective.
It seems that surprises are the one thing that the Fed tries to avoid. Policy makers are really unhappy when they cause multiple-standard deviation moves in stocks, rates or currencies. It considers this to be a failure. Why? If there’s a problem with volatility in the markets these days, it’s not that we have too much, but too little.
Many have observed that the overabundance of Fed speeches -- sometimes several in a day -- often send conflicting messages about its intentions, creating a lot of confusion in the process. There are 16 voices on the Fed, each with an opinion. Honestly, this is all a bit too much information. We were all happier not knowing how the sausage was made. The drive for transparency has substantially reduced clarity.
Forward guidance is a different issue than transparency, but the two are related. The Fed sometimes announces its rate intentions more than a year in advance. We have been told that there will be three rate increases in 2017. What if the economy improves further? What if the inflation rate goes markedly higher? Will an additional rate hike be justified?
How will the Fed go about communicating a change in intentions? For sure, forward guidance can be helpful, such as when the Fed was pledging to keep rates at or near zero for an “extended period.” But such guidance also means the Fed can find itself locked in to a course of action. Deviations can cause rapid adjustments in expectations and volatility. It is like the movement in the plates of the earth’s crust -- you don’t want rapid adjustments. Too much forward guidance squashes volatility and breeds complacency, which can lead to bigger problems down the road.
Adjusting expectations can be especially hard when you consider that the Fed is not just a faceless government institution but a collection of fallible human beings. If you’re an authority on economic matters, and you say you are going to do X, and your forecasts turn out to be wrong, what happens? You have to publicly say that you were wrong and you have to do Y instead. Do you know how hard it is for the government to admit that it is wrong?
I have worked in both the public and private sectors. If you work in the private sector, the worst thing that can happen is to lose money. That will get you fired. If you work in the public sector, the worst thing that can happen is to be embarrassed. The Fed tries hard to avoid being embarrassed. So when the Fed is forced to deviate from its guidance, the adjustment doesn’t end up being any less painful than if they had been operating in secret to begin with.
Ideally, you would want to be a central bank to be:
- A good forecaster
- If not, then nimble.
The Fed has had some pretty legendary failures in forecasting, but they aren’t much worse than most private-sector economists, so I don’t want to belabor the point. But if the Fed is going to be wrong about the economy -- possibly often -- you want it to have the ability to quickly correct its mistakes. But today’s Fed is not nimble. By communicating policy intentions more than a year in advance, they will be glacially slow to respond to a recession, which can happen fast.
The real danger of too much transparency is that the Fed will lose its veneer of omniscience. You look at the man behind the curtain, and it’s just a dude. The striking thing about the Kashkari post on Medium was how primitive the reasoning was. It’s not bad reasoning or dumb reasoning, just basic reasoning. It’s the thought process that you or I would have if we were Fed officials. He’s just a guy my age looking at the same stuff I am -- and coming to markedly different conclusions.
When a regional Fed President is telling you he uses Gillette Fusion razors to shave his head, there’s too much transparency. I’m a bit nostalgic for the days when economists were looking through money supply entrails to figure out what was going on at the Fed. There are no secrets left in the temple.
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