The effectiveness of monetary policy depends in part on how monetary authorities communicate with the market. Monetary authorities need to strike a balance between rules that increase policy transparency and discretion, which maintain policy flexibility. “If you think you understand exactly what I mean, then you must have misunderstood what I meant.” This is a famous quote by former Federal Reserve Chairman Alan Greenspan, who emphasized flexibility. After taking over as Fed chairman from Greenspan, Bernanke favored greater policy transparency. Bernanke believes that “for monetary policy to exert influence, 98% depends on propaganda, and 2% depends on policy itself.” This is concentrated in forward guidance, an unconventional monetary policy tool, whose importance lies in federal funds. This becomes even more pronounced when interest rates fall to zero.
Don’t just stop at “biting words”
In the Bernanke era, the Fed’s forward guidance was more institutionalized and transparent, and an important agenda was the establishment of inflation targeting. This helps the market better understand the Fed’s behavioral patterns and also helps maintain political independence. In terms of policy effect, QE (quantitative easing) combined with forward-looking guidance can further reduce the term premium and amplify the expansion effect of the easing policy. Conversely, balance sheet normalization (referred to as “shrinking balance sheet”, QT) plus forward guidance can minimize the term premium and alleviate the contractionary effect of the tightening policy. A classic example of the effectiveness of forward guidance is the 2012 ECB President Mario Draghi’s “whatever it takes” speech that almost instantly reversed the market’s pessimistic expectations for the euro.
An important part of the forward guidance is “words”. When QE1 was launched in March 2009, the Fed stated that “the federal funds rate will be at abnormally low levels for an extended period of time”. Compared to Greenspan’s time, the formulation is straightforward, but not straightforward enough—neither how long the “long period” will be, nor the conditions for raising interest rates. Rather than a credible promise, it is more of a pessimistic outlook for the future, which not only fails to spur growth, but is counterproductive. This statement has been maintained for nearly two years. In hindsight, the effect was not significant.
Bernanke has been experimenting with new expressions, and further clarified in his statement after the September 2011 regular meeting that “the ultra-low federal funds rate will continue at least until mid-2013”, that is, for the next two years, the Fed will There will be no rate hikes. This time-dependent rule is more concise and conveys a clearer message. But it sacrifices policy flexibility. If the economic recovery is stronger than expected, the Fed will be in a dilemma. Philadelphia Fed President Charles Plosser advocates state rules — clarifying the circumstances in which a certain policy applies. Bernanke believes that in the current environment, the market needs a clear signal of easing, so it is more inclined to time rules. The January and September 2012 regular meetings were extended to “at least the end of 2014” and “mid-2015” respectively.
The December 2012 regular meeting adopted a proposal by Chicago Fed President Evans to change the wording of the forward guidance: “Unemployment remains above 6.5% and inflation does not exceed 2.5% and long-term inflation expectations remain moderate. The target range for the federal funds rate will remain at 0-0.25%.” For the first time, the Federal Reserve explicitly allowed a temporary overshoot in the inflation rate in order to achieve a faster recovery in the labor market. It should be noted that 6.5% is a threshold, not a condition to trigger a rate hike – the Fed will only consider raising rates when the unemployment rate falls to 6.5%. The transition from time rules to state rules clarifies the phased goals of the policy and increases the flexibility of the policy.
The Fed’s innovation in forward guidance did not stop at words, and in January 2012, it released the first monetary policy principles and practices in its history and the “Long-term Objectives and Monetary Policy Strategy Statement” (hereinafter referred to as the “Statement”). The statement opens with a clear statement, saying the Federal Open Market Committee (FOMC) “seeks to explain its monetary policy decisions as clearly as possible to the public. Clarity of signals helps households and businesses make well-informed decisions and reduces economic and financial uncertainty. increase the effectiveness of monetary policy, and enhance transparency and accountability, which are crucial in a democratic society.” Among them, “reducing economic and financial uncertainty” refers not only to the United States, but also to the spillover of the Fed’s monetary policy overseas. effect.
The statement not only clarified the 2% inflation target system, but also clarified the meaning of “maximum employment”. The FOMC believes: “A 2% inflation rate is most consistent with the Federal Reserve’s statutory mandate over an extended period. Clearly communicating this inflation target to the public helps to firmly anchor long-term inflation expectations, thereby promoting price stability and sustaining a moderate long-term interest rates, and enhance the Committee’s ability to promote maximum employment in the face of major economic turmoil.” Bernanke argues that a 2 percent inflation target helps balance the Fed’s dual mandate: it is low enough — consistent with its mandate of price stability , and high enough to provide enough room to cut rates before they hit the zero lower bound to maintain the Fed’s ability to pursue full employment.
So why not quantify the “full employment” target, for example to specify a desired level of unemployment? The statement explained: “Maximum employment is largely determined by non-monetary factors that affect the structure and dynamics of the labor market. They may change over time and may not be directly measurable. Therefore, providing for employment A fixed target is not appropriate. Instead, FOMC policy must be based on an assessment of the highest level of employment, recognizing that such assessment is necessarily uncertain and needs to be revised.” In practice, the Fed will broadly Refer to labor market indicators, such as wages, labor force participation rate, the number of people receiving unemployment benefits for the first time, the employment rate of the population of different age groups, etc., and take the “natural unemployment rate” as a long-term goal of monetary policy.
Another important element of the Fed’s forward guidance is its regularly released and continuously refined macroeconomic forecasts. Beginning in 1979, the FOMC has issued semiannual economic forecasts over a two-year period as part of its Monetary Policy Report to Congress, but it has received little attention. At its September 2007 regular meeting, the FOMC approved Bernanke’s plan to increase the frequency to quarterly releases and extend the time span to three years. This is the widely watched Summary of Economic Projections (SEP, see table), which contains forecasts for four variables: output growth, unemployment, headline inflation and core inflation. Since its release, the content of SEP has been continuously improved. In January 2009, a “long-term forecast” was added, roughly equivalent to 3-5 years. Among them, the long-term unemployment rate forecast is the “natural rate of unemployment” assessed by the Federal Reserve. Long-term forecasts are based on the premise of “appropriate monetary policy” and therefore indirectly convey monetary policy objectives. The forecast, released in January 2012, included for the first time the future path of the federal funds rate, a rate “dot plot,” and a bar chart summarizing the governors’ forecast for the year the funds rate was first raised. So far, the Fed’s forward guidance system has been improving day by day.
Although forward guidance is also a kind of unconventional monetary policy tool, it is not limited to use in the period of “zero interest rate”. It is an interaction between the Fed and the market. The Fed can both gain insight into what the market is thinking and use it to achieve policy goals. When the Fed wants to change its policy stance, it can guide the market to take a step ahead, and the policy will not cause market volatility when the policy follows up. Clear rules appear to be a constraint, but they are also a form of freedom—”constrained discretion.” This is related to the special status of the Fed in the “separation of powers” system in the United States. As the “fourth power” institution, the Fed has an “unelected power”. Although the president has the right to nominate the chairman, once approved by Congress, he no longer has the right to recall. Clear rules help keep the Fed politically independent. The rules themselves are clear, but the enforcement of the rules is flexible. Rigid adherence to rules can indeed improve policy predictability, but rules are not all-encompassing, cannot predict “black swans”, and cannot guide the Fed on how to respond to “black swans” and “gray rhinos.”
To sum up, in the post-crisis era, in order to improve the effectiveness of monetary policy, the Federal Reserve has strengthened forward guidance, strengthened communication with the market on monetary policy objectives, rules and paths, and improved the transparency of rules and the accuracy of signal transmission. Expanded the boundaries of monetary policy. Before becoming a FOMC director in 2002, Bernanke deeply recognized the importance of monetary policy transparency and signal accuracy in his research. After becoming chairman of the Fed in 2006, Bernanke was most worried about two kinds of differences: one is the differences between the FOMC governors; the other is the differences between the FOMC and the market. Either way, it may cause panic in the market. The 2013 “Taper Panic” is a classic example of the opposite. The 2021 “taper tranquility” argues for this in a positive light.
Lessons from the scale-down scare: Communicating with the market requires understanding the market
Bernanke admitted that although the implementation of the third round of QE did not meet any resistance, everyone including him thought that the open QE was like a “gamble” and did not know how to end it. Just half a year later, three voting governors, including future Fed Chairman Jerome Powell, began to loosen their will, expressing concerns about the side effects of unlimited QE. By early 2013, the pace of the US economic recovery was more robust, and the unemployment rate had fallen to 7.5%.
To accommodate their opinions, at the March 2013 regular meeting, Bernanke said it would be appropriate to begin tapering the scale of asset purchases (Taper) “at one of the next few meetings”. Bernanke’s message is that the Fed is seriously discussing Taper, but has not yet decided when it will begin. In private discussions with the three directors, Bernanke said it could be September, maybe even June. Investors and the media did not catch the signal. The primary dealer survey expects QE3 to last longer. The message at the April meeting was roughly the same as in March, with Bernanke saying, “The Committee will be prepared to speed up or slow down the pace of securities acquisitions based on changes and prospects in the labor market or inflation.” He wanted to stress Taper’s flexibility, but The market’s attention is on the word “acceleration”, thinking that the Fed will start Taper in the near future. Once the Fed’s policy is out of touch with market expectations, financial markets may experience violent shocks. Therefore, Fed officials need to guide expectations in public and bridge the gap.
On May 22, 2013, during a hearing before the Joint Economic Committee of Congress, Bernanke stated more definitively, “If we see continued improvement, and believe that this will continue, then in the next few sessions, we will The pace of bond purchases can be gradually slowed down.” This hearing was regarded by the market as the Fed’s first taper signal. What Bernanke wants to emphasize is: (1) The condition for starting Taper is that the economy is substantially improved, and the improvement trend is sustainable; (2) Taper is not static, it will speed up or slow down according to the economic operation. In other words, the Fed will even increase the scale of asset purchases once the economy shows signs of weakness; (3) will not rush to raise interest rates after the end of Taper. Bernanke highlighted the risks of premature Taper, hoping to reverse market expectations.
However, the minutes of the meeting, released later in the day (the April regular meeting), said that while “most” FOMC members felt that there had been some progress in the labor market since the launch of QE3, “many” participants wanted to see more progress before Taper. much progress. “Some” attendees also said they would be willing to decide when to launch Taper “as early as the June regular meeting” if the evidence for further improvement is strong enough. The market interpreted the meeting minutes as a “hawkish” stance, and the stock and bond markets immediately went into “panic” mode because the minutes did not clarify what “further improvement” meant.
The June meeting clarified that one of the criteria for “further improvement” is for the unemployment rate to fall to 7%. According to the latest SEP, this level will be reached by mid-2014 (and will fall to 6.5% by early 2015 – the threshold for rate hikes). At that time, the Fed will stop buying assets, in accordance with Taper’s rhythm, which means that Taper will be launched at the end of 2013. In the statement, Bernanke said that if the data continues to improve, he will vote on whether to taper at the September meeting, and again stressed that Taper is measured. Overall, the June statement continued the “hawkish” stance, but was more “dovish” than the May minutes.
Bernanke thinks the May-June communication seems to be effective, as the June Survey of Primary Dealers is also expected to launch Taper in December 2013 (and possibly September). However, there was still panic in the financial markets – tapering panic, a rapid rise in long-term Treasury bond rates, a sharp pullback in the stock market, and even started to trade in rate hike expectations. By the time Taper was launched in December, the 10-year yield had risen by 100 basis points. Although the tapering scare did not significantly affect the recovery process in the United States, it was no small disaster for emerging market countries.
Bernanke thought that the disappearance of the expectation gap would not cause panic. It was only later found that the primary dealer survey did not represent the whole market, it more represented the views of economists, and market participants represented by traders still thought that QE3 would last longer. It turns out that the “scale back scare” is just the disillusionment of the “infinite QE” illusion! Before you communicate with the market, you must first know exactly what the market is thinking. As a lesson, starting in 2014, the Fed expanded its market research to include institutional investors, conducting a Survey of Market Participants (SMP) before each FOMC meeting.
Since the beginning of this century, more and more central banks in the world have been strengthening their communication with the market, and not limited to financial market participants, but also the general public, such as opening up a column of “popular education” on their official websites; on social media Popularize knowledge in a language that the public can understand; central bank policymakers increase media exposure, etc. Because the behavior of the masses is an important channel through which monetary policy works. The effectiveness of forward guidance depends not only on the efficiency of knowledge or information dissemination, but also on the reputation of the central bank. So the Fed is particularly concerned about political independence—not independence in an absolute sense, but “independence within the government.” Only by maintaining political independence can “politically incorrect” but necessary decisions be made. This is the original intention of creating the Federal Reserve.