Unconventional: A Policymaker's Reflections on Crisis to Recovery
"Not that long ago, the workings and decisions of the FOMC were kept behind closed doors. It wasn't until the 1990s that it began to officially announce its actions and any changes in the policy rate. In the 2000s, as the FOMC worked to contain the financial crisis through the use of extraordinary monetary policy and lending programs, it became imperative to better communicate its thinking to financial markets and the private sector. The Fed has taken unprecedented steps to improve communications ever since so there are fewer misunderstandings or surprises about Fed policy, less market volatility and better macroeconomic outcomes."
—Cletus Coughlin, Senior Vice President and Chief of Staff to the President
James Bullard shared some reflections on his first 10 years as Bank president during recent conversations with staff. The following are excerpts from those discussions.
When I first started at the St. Louis Fed in 1990, the FOMC did not even make an announcement or release a statement about decisions that had been made. It left it to financial markets to divine decisions by looking at trading patterns in short-term, overnight interest rate markets.
In 1994, with the debut of the FOMC statement, an era of evolving transparency began. Over the next 10 years, the statement became more informative, and minutes of each FOMC meeting more accessible.
It was a good start, but still too opaque with the onslaught of the financial crisis and the 10 years of unconventional monetary policy that followed. Between 2007 and 2012—with unprecedented decisions that brought the zero lower bound, quantitative easing, Operation Twist (extending the average maturity of Treasury securities), liftoff and unwinding the balance sheet—FOMC communications became central to effective monetary policymaking. Markets and the public needed to understand the central bank in real time. It was a major and important journey.
In April 2011, Chairman Ben Bernanke held the first press conference after an FOMC meeting. Press conferences are timed with the FOMC's SEP, which is released four times a year and has included the dot plot since 2012. In addition, in 2012, the FOMC named an explicit, numerical inflation target.
The large size of the FOMC—19 members (seven Board governors and 12 Reserve bank presidents) when at full strength—helps with communicating more or less continuously. I think that's very helpful in keeping the markets in sync with the Fed. As my predecessor, Bill Poole, would have said, you don’t want private sector expectations to get misaligned with FOMC intentions, and you want to keep those together as much as possible.
While these were monumental steps forward in transparency, there is still more work to do. In my view, it's just better policymaking to be communicating effectively with the private sector more or less all the time. New things are happening in the economy every day. New data have come out, other central banks are taking action, there's new foreign exchange information, or there are political revolts and upheavals. And the markets want to know how such changes will affect Fed policy.
I think we could start with a press conference at every meeting. Press conferences are currently held after only four of the eight regularly scheduled meetings. As a result, meetings that are not followed by a press conference tend to be thought of as ones at which taking an important action is unlikely. Consequently, the risk is to make moves that are calendar-based and to miss out on some moves that the data would support simply because no press conference is scheduled. If there were a press conference after every meeting, then all meetings would be "ex ante" identical—the FOMC could make a decision if it's appropriate at that particular meeting. (For more discussion on state-contingent versus calendar-based policy, see QE3: Data-Driven, Not Date-Driven in this annual report.)
In addition, improvements could be made regarding the FOMC's forecasts of macroeconomic variables published each quarter in the SEP. The SEP has a checkered history, and it can be confusing and misleading. The main problem is that the forecasts are unconnected and unattributed. Currently, each FOMC participant submits his or her projections for real output growth, the unemployment rate, overall inflation, core inflation and, as of 2012, the future path of the target federal funds rate. The Fed publishes summaries of the projections without attribution to individual participants.
Furthermore, the sets of forecasts that the FOMC participants submit are based on various models and policy assumptions. Each projection is based on the optimal policy from that person's point of view, not necessarily what the FOMC is actually going to do. The report does not reflect any sort of FOMC consensus, and it does not capture statistical uncertainty or a range of possible outcomes. This contributes to even greater interpretation problems.
So, while the SEP provides useful information, communications about how the FOMC views the economy could be improved. Other central banks put this out as a collective committee staff forecast, and that’s the way we could do it as well.
One way would be to replace the SEP with a quarterly monetary policy report that better explains the FOMC's actions and projections on a regular basis. It would include a staff forecast as a baseline of what the Fed expects, and FOMC participants could then give their views/forecasts relative to that baseline. The report could also provide more color commentary on various developments on the economy. The Bank of England was a trailblazer in this area with its inflation report. Many other central banks also do this.
I also think we could do more on policy rules in a quarterly monetary policy report. Such a report could provide a more complete discussion of how the FOMC views the current state of the U.S. economy and its expectations going forward. It could include a regular discussion of various monetary policy rules and explain why any deviations from those rules seemed appropriate at that time. The FOMC has already been using policy rules for many years in its internal deliberations, so I don't see anything that would inhibit the Fed from talking in terms of policy rules and deviations from policy rules.
The "taper tantrum" of 2013 is an example of what can happen when communication signals between the Fed and financial markets get crossed.
In the spring of 2013, QE3 was in full swing; the Fed was purchasing $85 billion per month in longer-term Treasuries and mortgage-backed securities. As the economy continued to slowly recover, questions began to arise as to when the Fed would begin to reduce, or taper, the QE program. To date, the FOMC’s messaging on this topic had remained steady, and financial markets remained relatively calm.
Then communications about the future of the program began to emerge. In May, Fed Chairman Ben Bernanke indicated during his testimony before the Joint Economic Committee that the Fed could begin to taper if and when economic conditions warranted. A few weeks later, at its regular June meeting, the FOMC voted to continue QE3 at the pace of $85 billion per month. But Bernanke discussed a tentative future tapering time frame during the post-meeting press conference.1
Markets reacted abruptly: Bond and stock prices tumbled, and market volatility surged. This period became known as the "taper tantrum."
"The essential decision by the FOMC at that meeting was to do nothing, but that left the chairman to explain at the press conference what the future strategy would be with respect to the pace of asset purchases," James Bullard said.
"I dissented at the June meeting because I didn’t think that this was a good way to proceed, and I thought it would come off hawkish," he recalled.2
In September, the FOMC surprised markets in the other direction. Markets expected the FOMC to announce that it would begin tapering. When the FOMC made no such announcement, some of the financial market effects following the June meeting were then reversed.
When the FOMC formally decided in December to begin tapering, the decision was met with very little market reaction. The actual reduction in the pace of asset purchases throughout 2014 went smoothly, and the FOMC ended QE3 in October 2014.3
“The taper tantrum was a communications problem, and that is its great lesson for us as monetary policymakers,” Bullard said. “It was all about communicating future policy action, not about actual changes in policy.”