Bernanke’s forward guidance is clear as mud

Posted Thursday, Jun. 20, 2013  comments  Print Reprints

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Federal Reserve Chairman Ben S. Bernanke seemed a little nervous at his Wednesday news conference. His recent comments about the future course of monetary policy had rattled investors and driven bond yields up, tightening financial conditions in a way the Fed didn’t want.

Formally unperturbed, Bernanke said he was leaving policy unchanged — but in trying, yet again, to elucidate the Fed’s thinking, he tacitly admitted that something had gone wrong.

Fortunately, the policy itself is basically good — but that’s despite, not because of, the ever-evolving formulas used to explain it.

Growth in the United States is still sluggish, unemployment is still high and inflation is (a) running well below the Fed’s target and (b) falling. That suffices to justify interest rates at zero until further notice, together with additional large-scale asset purchases — which is what the Fed intends.

There are dangers in this policy, to be sure. Quantitative easing is an experiment and involves risks.

Bernanke summed these up drily in a recent speech: There’s the risk that long- term interest rates will remain low (leading investors to recklessly “reach for yield”) and the risk that they won’t (imposing losses on investors when rates rise and bond prices fall).

The point is, in current circumstances, every course involves risk. Tightening monetary policy prematurely, as Bernanke has often explained, courts the greatest danger — that of bringing a hesitant recovery to a stop. On a balance of risks, aggressive monetary stimulus still makes sense.

Bernanke triggered the recent rise in long-term bond yields when he said last month that “in the next few meetings, we could take a step down in our pace of purchases.”

You could argue that he was merely stating the obvious, but the markets took it as important new information. The problem for the Fed is that investors didn’t interpret it as good news about the economy but as bad news about the Fed’s reliability.

As the economy strengthens, you’d expect long-term interest rates to rise. But the recent rise in bond yields coincided with unexciting jobs data and very low inflation — inconsistent with the “strong economy” story.

The implication is that investors thought the Fed was bringing forward its plans not just to taper QE but also, crucially, to start raising short-term interest rates.

Bernanke tried to address this confusion this week. He emphasized for the umpteenth time that the decision on tapering QE is separate from the decision on starting to raise short-term rates.

All being well, tapering would probably start later this year, he said, with asset purchases continuing in 2014 until unemployment falls to 7 percent.

Interest rates won’t rise, the Fed has previously said, until unemployment has fallen to 6.5 percent. And, Bernanke added with fresh emphasis, perhaps not even then: These numbers are “thresholds” not “triggers.”

So the Fed will merely start thinking about raising interest rates once unemployment falls to 6.5 percent and might well choose not to act at that point.

Is that now clear?

Bernanke means to assure the markets that stimulus won’t be withdrawn abruptly or too soon.

The Fed isn’t about to apply the brakes.

But if you ask under precisely what circumstances the stimulus will eventually start to be withdrawn, the new refinements really don’t help.

Central bankers don’t want to be tied to a simple formula when there are so many moving parts — they want to retain some discretion.

That vagueness, in turn, allows for bond-market glitches like the one of the past few weeks, as investors ask, “What on earth did the Fed mean by that?”

To repeat, the policy is right, and that’s the main thing. But Bernanke’s commitment to transparency and forward guidance has made his job harder.

That’s why we’ll be debating what he really meant until he gives his next speech — and that, if you’re wondering, is a threshold, not a trigger.

Clive Crook is a Bloomberg View columnist.

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