Last September, after announcing open-ended asset purchases and making his first strong commitment to allowing above-target inflation (and keeping monetary policy accomodative) even after the economy strengthens, Ben Bernanke made an interesting point about the Fed’s credibility to make such a future promise.
It was about the fact that the voting membership of the FOMC changes over time:
We’ve talked a lot, both publicly and privately, about the rationale for keeping rates low even as the economy strengthens, and the basic ideas are broadly espoused within the committee. So there is a consensus that even as personnel changes and so on going forward that this is the appropriate approach and that by following through we will have created a reserve of credibility that we can use in any subsequent episodes that occur.
(Emphasis ours, and the comments are from that meeting’s presser.)
Later, at the December meeting, the FOMC formalised the approach for rates policy by enacting the Evans Rule.
The result was Bernanke had essentially defended looser monetary policy against a future hawkish shift until those numerical thresholds were reached. That was the whole point — the members who voted in favour of it would have to go back on their word if they later voted to raise rates early.
Between the governors on the FOMC, the 2012 Fed presidents who voted in favour of numerical guidance in December, and the Fed presidents who rotated in and have voted for it this year, that’s a fairly significant percentage of the FOMC that has committed to an explicit policy of low rates for longer.
Yes, there were always caveats — the committee looks at a variety of factors; the numbers are thresholds rather than targets; and a member can always change his or her mind under new circumstances, and so forth. But such a reversal would be glaringly obvious, and would bring with it the burden of explanation for a mind changed, a promise unkept.
But of course, that only applied to rates communication, not to communication about asset purchases. The variables governing the pace and eventual end of QE have remained vague and somewhat qualitative, hinging on some definition of “substantial improvement” in the outlook for labour markets and increasing the economy’s “near-term momentum”. And when Bernanke raised the possibility of tapering sometime later this year — rather clumsily, we hasten to add — the markets reacted with unexpected intensity.
Since then he has managed to talk them down to some extent: equities are roughly back to their pre-meeting levels but yields have stayed elevated.
Bernanke had previously said that numerical guidance for QE would be more effective, and Wednesday’s FOMC minutes indicated that it had been discussed at the June meeting — but such a move no longer seems likely given the amount of internal disagreement within the FOMC about when to taper, as revealed by the minutes. And because precise guidance about the future path of QE was never agreed or voted on by the FOMC, the varying and conflicting opinions of its members are important.
We don’t mean to exaggerate the issue. Bernanke has the votes he needs to do what he wants with tapering through the end of the year. But the unexpected reaction from markets in the past month at least demonstrates again that the possibility for misunderstanding is a function of the Fed’s unwillingness to make a clear commitment.
On this particular aspect of monetary policy, there can be only very little clarity about what will happen next year under a new Fed chair, and also very little clarity about how views will change within the FOMC.
And the markets have just demonstrated that they care very much indeed about the future evolution of those views.
At the presser following the June meeting, reporter Ylan Mui of the Washington Post asked Bernanke about the possibility that he would be leaving as chairman next year, as now seems likely.
His response was uncharacteristically brusque:
Well, Ylan, we just spent two days working on monetary policy issues, and I would like to keep the debate, discussion, the questions here on policy. I don’t have anything for you on my personal plans.
He was wrong to be dismissive. His future presence on the committee is a policy question. By not committing asset purchases to clearer guidance, Bernanke himself saw to that.