By: Phil Kernen
Over the last 25 years, the Federal Reserve has become more transparent than ever before. Much of this is the result of political pressure. Still, the Fed has taken it further, believing greater transparency to be a good thing to help the public understand the likelihood of future policy changes. Talking more may have helped us move past the 2008 financial crisis, but it isn’t helping us now.
Congress created the Federal Reserve in 1913. The Federal Reserve is nominally independent but must answer to Congress, who can change the rules under which they operate or dissolve it altogether. For the first sixty years, Congress granted a great deal of latitude to the Fed, who communicated as little as possible, believing that transparency made policy less effective rather than more. Market participants could only divine policy decisions based on open market operations. That changed in the late 1970s as inflation breached 10% amid an 18-month recession. Congress revised the Federal Reserve Act to forcibly impose new disclosure requirements on the Federal Reserve after they rejected repeated requests.
In the 1990s, Congress raised the issue of greater transparency again. The Fed’s degree of insularity was such that it took years for lawmakers to determine that the Fed kept transcripts of their deliberations. When the Fed rebuffed Congress’s request for those transcripts to be regularly released, Congress threatened to legislate again. The Fed eventually complied by releasing a post-meeting statement and releasing transcripts with a lag.
Over the next decade, the Fed took steps toward greater transparency, augmenting disclosures required by Congress. Self-mandated communication grew by leaps and bounds following the 2008 financial crisis. Traditional monetary tools were far less effective and quickly cast aside in favor of newly created approaches. Many of these monetary tools relied on verbal guidance from the Fed to help set expectations in the public mind, which meant talking more, giving more speeches, and engaging in more interviews. It worked well when the plan was essentially to keep interest rates lower for longer. The same idea was behind the 2% inflation target offered up publicly in 2012, culminating a debate that started in the mid-1990s.
Conditions have changed over several years, and a turning point came in late 2018. The Fed had slowly been raising interest rates for two years. Chairman Jerome Powell gave an interview stating that the U.S. economy was “a long way from neutral,” meaning the point at which interest rates are neither spurring nor slowing economic growth. Equity markets and President Trump registered their displeasure. The latter let loose a series of disparaging tweets, breaking with a tradition that kept Presidents removed from commenting publicly on monetary policy.
Meanwhile, the stock market fell 13%, and the Fed raised rates for the last time in December 2018. The economy hadn’t fundamentally changed; it was still growing slowly, but public pressure took control of the Fed narrative. 2019 ushered in another series of rate reductions leading into 2020 and the onset of the pandemic.
We now sit nearly two years into a pandemic. The U.S. economy is expanding modestly due to growing demand and supply chains that can’t keep up. The Omicron COVID variant is the current challenge, and others will follow. Fiscal policy is uncertain, and inflation has solidly taken root, forcing the Fed to react. The transparency that served the public well when the Federal Reserve could better see the future isn’t helping now. Things are moving fast, conditions are changing quickly, and Fed voters are working on a meeting-by-meeting basis. Their public commentaries, interviews, and speeches don’t help clarify matters. They think aloud and try to develop their views in a public forum. They can’t tell us where rates will be 6-12 months from now. We are in uncharted waters, and they have no better idea than anyone else.
The Fed must meet the politically mandated transparency required by Congress. Beyond those minimum expectations, however, it is time for the Fed to walk back some of the communication methods adopted over the last decade. To be transparent, sometimes you can say too much and cloud the message you strive so hard to clarify.