The year 2012 will be remembered as the year the U.S. Federal Reserve stepped into the light.
As soon as this month, chairman Ben Bernanke will transform the Fed into one of the most transparent central banks in the world, a hard-won victory within an institution that clung stubbornly to the notion that monetary policy is best made behind a cloak of obscurity.
The Fed over the past few months has intensified its work on a new communications strategy. In 2011, Mr. Bernanke became the first chairman to convene a scheduled press conference. Every indication suggests the Fed’s version of “glasnost” will continue.
According to the minutes of the November meeting of the Fed’s policy committee, “a majority of participants agreed that it could be beneficial to formulate and publish a statement that would elucidate the committee’s policy approach, and participants generally expressed interest in providing additional information to the public about the likely future path of the target federal funds rate.”
More clues will be revealed Tuesday when the Fed releases the minutes of the policy committee’s December meeting. Analysts say the Federal Open Market Committee could complete its new communications strategy at a two-day meeting ending Jan. 25, which will be followed by the first of four press conferences that Mr. Bernanke has scheduled for 2012.
Some will shrug at this. The Fed has flooded the financial system with hundreds of billions of newly created dollars over the past couple of years. Why the hype over a new public relations campaign?
Anyone asking that question has been spoiled by the Reserve Bank of New Zealand, the Bank of Canada, the Riksbank of Sweden or the dozens of the other official lenders that adopted formal policy targets years ago. Research and experience show central banks can more easily achieve their goals if the public understands what policy makers are trying to achieve.
Clear communication becomes even more important with benchmark interest rates at zero, as is the case in the United States. In fact, it becomes a form of stimulus in itself. Record-low borrowing rates are a powerful incentive to spend and invest. But the impact can be limited by uncertainty. If households and companies are wary of an increase in interest rates, they will resist spending. Central banks can coax that money into the economy by being explicit about when borrowing costs will rise.
The Fed moved in this direction this year by stating its intention to leave its benchmark rate at extremely low levels until the middle of 2013. Investors listened: a Barclays Capital analysis of prices of financial assets linked to the Fed funds rate shows market participants expect U.S. interest rates will remain at current levels until the end of 2013. In August, investors were expecting an interest-rate increase by the end of 2012.
But the Fed can be clearer still. The Fed’s mandate from Congress is to achieve “maximum employment” and “stable prices.” A numerical inflation objective and a target for the unemployment rate would provide greater certainty about when interest rates will rise. Both ideas are part of the Fed’s communications discussions. The Fed also is considering releasing the forecasts for the benchmark interest rate of each policy committee member, which is about as transparent as a central bank can be.
To understand the significance of the Fed’s embrace of clarity, recall the “briefcase indicator.”
CNBC would guess at the central bank’s stance by observing the thickness of Alan Greenspan’s briefcase as the former chairman entered the Fed’s Washington headquarters on the day of policy committee meetings. Thin meant Mr. Greenspan was untroubled by the state of the economy. If the briefcase was stuffed full, it meant Mr. Greenspan was concerned enough to carry home lots of reading material the night before and an interest-rate increase loomed.
“For the record, the briefcase indictor was not accurate,” Mr. Greenspan wrote in his memoirs, which were published in 2007. “The fatness of my briefcase was solely a function of whether I had packed my lunch.”
CNBC’s “coverage” of Mr. Greenspan’s briefcase was a stunt, and the former chairman admits he played along by continuing his habit of entering the Fed on foot through the front door. But Mr. Greenspan also encouraged such gimmickry by giving reporters and investors nothing else to talk about. He refused interviews and press conferences. He also dismissed inflation targeting, even though it had been adopted by almost every other major central bank by the late 1990s. For Mr. Greenspan, monetary policy was an intuitive art. He felt that an explicit target would only tie his hands.
But clarity always had its advocates at the Fed, chief among them Mr. Bernanke, a noted champion of inflation targeting when he joined the Fed as a governor in 2002. A decade later, Mr. Bernanke finally is about to let some more light in. Some will argue that the Fed will have to do more quantitative easing to strengthen the economy. If that turns out to be true, everyone will at least have a clear understanding why.