March 15, 2022

Has the Gabby Fed Gone Too Far in Its Transparency Push?

The central bank’s greater openness these days fuels risky behavior and thwarts flexibility, some say.

Reported by Larry Light

Art by Mikey Karpiel

How did the Federal Open Market Committee become the Federal Open Mouth Committee? The once-secretive Federal Reserve, its policymaking FOMC, and the Fed’s chair now trumpet their intentions way ahead of time.

But is greater openness a blessing or a curse? A strong debate swirls over the question. Many welcome this new transparency as an aid to capital markets, giving investors and bankers the comfort of rate predictability. Others think the Fed’s blabby modus operandi has the opposite effect: To them, it encourages risky investing and diminishes the flexibility needed to adjust to events.

One thing’s a pretty good bet, thanks to the transparency M.O.: What the Fed’s policy panel will do this week. Unless the earth shifts on its axis, the Fed on Wednesday will announce a quarter-point increase in its benchmark short-term interest rate, part of a long-term campaign to lift the price of money in an inflation-wracked time. After the news release, Fed Chair Jerome Powell will conduct a press briefing, where he will explain what the FOMC has done and may do.

Surprises should be minimal to non-existent. The central bank has taken pains to prepare the public for higher rates, through Powell’s previous appearances, speeches by Fed governors and regional presidents, and a host of the agency’s economic forecasts.

But this fastidious telegraphing of intentions is relatively new to the Fed. Once upon a time, investors had no easy way of knowing what the organization was doing. To find out, they resorted to indirect methods, such as collating the size of banks’ excess free reserves, the amount of assets they hold as a cushion, over what the Fed mandates.

When Alan Greenspan served as Fed head, from 1987 to early 2006, he made a point of being inscrutable in public appearances. His jargon-laden, oracular, and turgid remarks did little to enlighten anybody about what the Fed was contemplating. In 1987 testimony before Congress, Greenspan said, “Since I’ve become a central banker, I’ve learned to mumble with great incoherence. If I seem unduly clear to you, you must have misunderstood what I said.”

Back then, in addition to examining bank reserves and the like, various rule-of-thumb methods were used to determine what the Greenspan Fed was doing. Like the Briefcase Indicator. If Greenspan’s briefcase was thick when he came to work, said Matt Lloyd, chief investment strategist at Advisors Asset Management, it suggested a policy change was in the works. He was hauling numerous documents to use as the Fed pondered making changes.

During the tenure of Chair Ben Bernanke (2006-2014), transparency became the new ideal. In a 2013 meeting with teachers, a gathering that Greenspan would never attend, Bernanke remarked, “A more open Fed, in my view, is both a more effective and more democratically legitimate institution.”

The peril here, of course, is that sometimes the Fed can cause a panic if it doesn’t calibrate the impact of its public statements. Such was the case following Bernanke’s 2013 declaration, in a seemingly off-hand comment, that the Fed was eyeing the gradual elimination of its bond-buying undertaking. This purchase program, called quantitative easing, or QE, started in response to the 2008 financial crisis, in a bid to lower longer-term rates and pump liquidity into the system.

The result of Bernanke’s admission: Investors madly dumped bonds, and the 10-year Treasury yield shot up, in a mess known as the “taper tantrum.” The next time the Fed wanted to unwind a QE effort, which had been launched to counter the pandemic’s ill effects, it laid the groundwork far ahead of time. A plethora of Fed figures, starting with St. Louis Fed President James Bullard last summer, talked up the idea of a QE tapering. The actual tapering announcement came in November.

To be sure, the seven governors (who oversee parts of the financial system) and 12 regional bank presidents don’t all read from the same script. Thus, Bullard often takes a hawkish stance, while Milwaukee Fed President Neel Kashkari is a dove (although he is in favor of two rate hikes at the moment). The free-ranging statements of some officials “seems to muddy the waters a bit with some contradictory opinions and communication at times,” said Bob Jacksha, CIO of the New Mexico Educational Retirement Board.

Certainly, the innerworkings of the Fed still stay behind a curtain. To get a glimpse of what might be brewing, Advisors Asset Management’s Lloyd tracks the number of public speeches that Fed officials give. The count signals a change in policy, he said. Since 2006 (Bernanke’s first year), the speeches have averaged 52 annually, which serves as Lloyd’s demarcation line for the Fed between an action agenda and a status quo mindset.

In 2019, the speech tally shot up to 62, as the Fed reversed its four-year-old drive to elevate rates. The speeches dropped to a low of 40 in 2020, when the Fed quickly reduced rates to near zero to offset the pandemic’s economic toll—not much discussion was needed for this emergency measure. Then in 2021, the count leapt to 65, as the economy bounced back and the Fed wrestled with how and when to tighten.

From Mute to Motormouth

The first step to make the Fed more transparent was in reaction to the stagflation-ridden 1970s. To wit, the enactment of the 1978 Humphrey-Hawkins Act, which mandated that the federal government must strive to maintain full employment—and included the Fed, which basically had been focused in regulating inflation, in that job-growth mission. “The thinking evolved from the Great Inflation” of that period, said Marnie Owen, head of content, Americas, at Informa Global Markets.

As a result, the Fed chair had to personally testify before Congress twice yearly. In 1994, the FOMC began releasing minutes of its meetings, although with a three-week lag. The intent of these efforts, as chronicled by Owen, was “to try to tell markets what the Fed was going to do.”

The Fed’s journey toward greater communication accelerated in the early 2000s, following the collapse of Asian currencies, Russia’s debt default, and one big made-in-America catastrophe, the dot-com bust, which helped trigger a recession. The Fed was forced to cut rates radically, a move that disconcerted the credit markets.

Spurred by these woes, the Fed, under the otherwise unforthcoming Greenspan, in 2003 began issuing its “forward guidance,” giving indications of the likely future course of monetary policy. After Bernanke took over, numeric forecasts appeared in 2007, followed in 2011 by the chair’s press conference and in 2012 by the FOMC members’ individual (if anonymous) predictions for rates up ahead, known as the “dot plots.”

Talk, Talk, Talk

Sunshine is inherently a boon. This is the rallying cry for advocates of a more open Fed, who argue that more transparency provides greater confidence for investors, plus enhances the Fed’s credibility, a vital need in a turbulent age. The more open approach “reduces the penumbra of uncertainty,” said Cheryl Smith, an economist and portfolio manager at Trillium Asset Management. “And that instills a bit of trust that the Fed knows what it is doing.”

There also is a broad educational aspect to a gabby Fed, reaching beyond financial pros, say fans of the concept. The many Fed voices airing the body’s roles and viewpoints “help the public understand the complexity” of economics and finance, Smith said. Fed speakers circulating throughout the land can explain that “economics is not hydraulics, where you put in quart of oil” and the engine runs with reassuring constancy, she noted.

In addition, a more open Fed diminishes the likelihood of policy mistakes, Smith said. The idea is that, by exposing Fed proposals to outside scrutiny, better outcomes ensue. Having a lot of Fed governors and presidents airing possible plans is “one of the Fed’s tools” to parse out what might be effective in the real world, contended Dave Harden, CEO and CIO of Summit Global Investments.

Keeping everything in-house, as in the pre-Bernanke days, courts disaster, in Smith’s eyes. She points to G. William Miller, the Fed chief during the inflation-bedeviled late 1970s, who kept rates low just when tightening was needed to stop the wage-price spiral that had gotten out of control. “Miller wasn’t doing anything,” Smith declared.

His successor, Paul Volcker, went too far in the other direction, she added: He pumped up the fed funds rate to 19% in 1981. That indeed squelched the inflation problem, but also spawned a wicked recession with unemployment that topped 10% by 1982. “You could say that was a policy error,” Smith said. “He didn’t balance it right.”

By contrast, the Fed chairs in the openness era did much better, in her view. Bernanke “did a phenomenal job” in the 2008-09 financial crisis, according to Smith. Following him, she went on, Janet Yellen (2014-2018) “was a steady hand” and Jerome Powell, who took over as chair in early 2018, rescued the economy from the pandemic.

Zip Your Lip

The counterargument: Maybe all this openness has gone too far and has unintended consequences. Finding someone who wants to return to the pre-Bernanke days is difficult. Still, the thinking here is that a loquacious Fed often overdoes it.

To Harley Bassman, managing partner at Simplify Asset Management, a talkative Fed risks “moral hazard,” the belief that it will always be at the ready to bail out the economy. The Fed thus gives investors “comfort that they face very little risk.” And that fosters taking too much risk.

Example: The Fed’s practice, before the financial crisis, was to assure the world that it would raise rates by 0.25 point every few months. This automatic practice had “a cost-benefit that was not worth the cost,” Bassman said. People could make sure-fire bets around this regular progression. Too bad that the blissful rate increases rendered mortgages increasingly less tenable in a rickety housing environment built on speculation. Cue the financial crisis.

These days, he continued, the dot plots give investors a likely misleading picture of where rates are headed. “They do more harm than good,” Bassman maintained.

Another minus is that the Fed’s forward guidance can hem in the central bank, said Bruce Monrad, head of Northeast Investors Trust. “They’ve made promises,” he said, “and those tie their hands.” One consequence: The Fed still is buying Treasury and agency mortgage bonds, when the time for that is past. To critics, this continued QE distorts the markets. “Transparency is not the Fed’s friend,” Monrad averred.

Beyond all these critiques, the plain fact is that “transparency is not quantifiable,” said Dan Phillips, head of asset allocation at Northern Trust Asset Management. That leaves the much-touted achievements of the openness strategy merely anecdotal. “The pendulum has swung too far. They need to do less public speaking.”

Whether the Fed will become suddenly reticent is doubtful. We’re left with a pretty solid assurance of what the Fed intends to do. Who knows if it is also wise?