The Federal Reserve needs to spend some time out of the spotlight. After experimenting with massive new policy initiatives since the 2008 crisis, the hyperactive U.S. central bank has already said it probably won’t raise rates for years. Now it’s considering specifying levels of unemployment and inflation which could change that. It’s a recipe for confusion.
Minutes from the last policy meeting in October, published on Wednesday, show central bankers debated the merits of ditching guidance that keeps interest rates near zero for a defined period of time – currently until 2015. Instead, they could provide thresholds for economic indicators that would trigger a policy rethink. The minutes don’t specify which indicators are preferred, but the Fed’s dual employment and inflation mandate and a speech this week from vice-chairman Janet Yellen make the jobless rate and some measure of prices the obvious contenders.
Saying short-term rates would stay low for years never seemed a great idea, though chairman Ben Bernanke was trying to manage market expectations. Despite the fact it’s only a forecast, investors mostly interpret it as a commitment – and that makes them too comfortable. Introducing thresholds might in theory help make them more alert to how Fed policy might change along with economic realities. But in practice it would probably make Mr. Bernanke’s job even more complicated.
First, there’s the problem of what the thresholds should be. Charles Evans, the Chicago Fed president, reckons short-term rates should remain zero-bound while the jobless rate is over 7 per cent and inflation under 3 per cent. His colleague from Minneapolis, Narayana Kocherlakota, sees the magic numbers at 5.5 per cent and 2.25 per cent, respectively. Even then, Mr. Bernanke will have to convince the public that such targets are triggers only for a re-evaluation, not necessarily for action. Otherwise he would compromise the Fed’s cherished flexibility.
Any attempt to convey such nuances is risky, with investors looking for simple messages. The Fed would be better off bringing back a little mystery. After all, until the crisis struck in 2008, there was a lot more of that. In fact, weaning markets off a running commentary from the central bank almost counts as a first step in the process of reversing the radical policies of recent years. Keeping quiet occasionally would finally let market forces begin to reassert themselves.