Overly expansive public communications reinforce the view that the Fed micromanages the economy, and lead to unnecessary market volatility.
At the Federal Open Market Committee (FOMC) press conference on Wednesday, Federal Reserve chairman Jay Powell painted a dire portrait of the U.S. economy. Despite positive news, such as the better-than-expected May jobs report, Powell suggested that collapsing GDP and sky-high unemployment would persist for the foreseeable future. Equity markets promptly saw their biggest one-day decline since the start of the coronavirus pandemic.
Ironically, Powell went to great lengths during the press conference to stress that the Fed wasn’t inflating asset prices, as an increasing number of financial commentators and investors have claimed. While there’s no evidence that the presser catalyzed the sell-off (Powell said he’s “not even thinking about raising rates”), Powell’s wide-ranging statements throughout the coronavirus pandemic underscore the outsize role of communications in monetary policy.
Quarterly FOMC press conferences began under Chairman Ben Bernanke in March of 2011. Previously, the Fed chairman would deliver a brief statement after FOMC meetings, and central-bank officials would otherwise speak publicly at their discretion. In early 2019, after a market sell-off that many attributed to poor central-bank communications, Powell announced that he would give press conferences after each of the eight annual FOMC meetings.
During his tenure, the statements accompanying FOMC meetings have grown longer and wider-ranging, following a trend that began under Janet Yellen. While the Fed chairman has long been seen as a kind of Delphic oracle, the steady increase in public appearances and statements has given central bankers extra influence over short-term economic fluctuations. At times, such as when Janet Yellen commented on biotech valuations in 2014, Fed officials appear to be fine-tuning asset prices.
According to the St. Louis Fed’s FRASER blog, “These modern press conferences are a conscious effort to make the business of the Federal Reserve — and the FOMC specifically — more transparent to the public.” Given the Fed’s increased use of forward guidance, FOMC press conferences also serve as a policy tool, allowing Fed chairmen to communicate their intended interest-rate targets years into the future. But the statements often obfuscate more than they clarify, leading to inexplicable swings in asset prices.
Economists at the New York Fed found that FOMC statements significantly increase financial-market volatility. “If stocks on a daily basis were as volatile as” they are immediately before and after FOMC statements, “annualized volatility would be 35 percent instead of the normal 8 percent,” they wrote. The economic projections and press conferences following FOMC meetings — which do not include policy announcements — amplify that volatility. While policy changes should be expected to move asset prices, the extent to which investors parse press conferences and projections is harder to understand. Fed economists perform no better than their private-sector counterparts in forecasting the trajectory of the economy, and even their estimates of the future federal-funds rate tend to be a worse indicator than market-discount rates.
But because those projections come from the Fed’s bully pulpit, they have a tremendous influence on financial markets and consequently on short-term economic activity. So too with press conferences, which observers use to peer into the Fed chairman’s brain.
Powell’s Wednesday statement included his assessment of the possibility of lifting social-distancing restrictions, as well a comment on the difficulties for women, African Americans, and Hispanics during the recession. One wonders how the conditions of various demographic groups factor into the Fed’s reaction function. Does a relatively higher unemployment rate for ethnic minorities call for looser monetary policy? Too often, FOMC statements veer into territory unrelated to the Fed’s dual mandate of full employment and price stability.
FOMC statements are useful as a means of giving forward guidance, but communicating future policy does not necessitate extraneous comments on short-term economic fluctuations or asset prices. The Fed should reorient communications to be more systematic, focusing on the interaction between monetary policy, inflation, and employment. Expansive, State of the Union–esque speeches reinforce the view that the Fed micromanages the economy, and lead to unnecessary volatility.
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