The theme of our recent series of posts on understanding FOMC actions and communications has been the well-disguised, steady predictability of FOMC policy.
The basic story is that policy is driven by a consensus on the FOMC. The consensus tends to evolve slowly and predictably, and for some time now, the consensus has behaved consistently as if driven by two principles:
So long as steady job market gains persist, continue a gradual, pre-announced removal of accommodation.
So long as inflation remains below target, take a tactical pause if credible evidence arises that the job gains might soon falter.
The factual record, I argued, is unambiguous: over the last three years, we’ve gotten normalization at a preannounced pace as in to the first principle, punctuated only by brief (so far) tactical pauses as under the second.[1]
But the fact that my low-drama story lines up with the facts doesn’t make it correct. And my story directly contradicts the popular narrative of a skittish, market-obsessed Fed flip-flopping at every opportunity. This is where the well-disguised part comes in.
Before continuing, however, I want to emphasize that I came to the views I’m describing during my years working on transparency and communications on behalf of the chairs Bernanke and Yellen—a job that ended about 2 years ago now. Yes, I did my small part in making the mess. But the FOMC members and Fed staffers like me also worked pretty hard to understand what was going wrong and attempting to improve the situation. This series of posts is essentially the lessons I took from these efforts. It would be inappropriate for me to say who among my former colleagues subscribes to these views, but I similarly don’t want to claim the ideas as my own. For now,[2] I’ll be deliberately and appropriately vague in saying that all the points I’m making were in the air at the Fed while I was there. In this post, I’ll sketch the basics, leaving details and support for subsequent posts.
The sketch goes like this. The 19 policymakers on the FOMC have, since the crisis held widely divergent views about policy.[3] Under the leadership of the Chair, these views somehow blend in a reasonably coherent compromise policy. That compromise by its very nature is fully embraced by no one. The vast bulk of FOMC communication (as a matter of policy) stresses the 19 views to the exclusion of the consensus. Individual FOMC members are often endlessly transparent about the various issues that are, at present, causing them to prefer something other than the actual policy. The chosen policy often appears to be an orphan, at best, and can become a whipping boy.
But the consensus policy is generally much simpler to understand than those 19 component views. For example, if the broad characterization of principal facts about the dual mandate evolve only slowly—as they have for the last few years—then the net effect on policy of all the grappling and speechifying is minimal.
Following FOMC communications in detail is like watching classical Greek tragedy: observing the drama unfold may be great entertainment, but this doesn’t change the fact that the outcome is inevitable.
You might think that folks on the outside would have figured this out—and this series of posts is intended to help in that regard. But there is a strong pull toward that ‘skittish, market-obsessed Fed’ narrative. And this narrative is very plausible. You can almost inevitably find some significant wiggle in financial market data to support any market obsession story. This provides a good starting point for persistent misconceptions. And with FOMC members making 19 different cases, you can also generally find support for your particular story in some FOMC communication.
Aside: this is why I asked you to read an earlier post as if you only knew of the FOMC statement and press conference: these are the principal places where the communication is unambiguously directed at explaining the consensus. As I’ll argue in greater detail for those who stick around for the more complete argument, communications other than these systematically obscure and confuse much more than they clarify.
So that’s the basic sketch. Let me summarize.
Over the last 3 years, the general picture regarding the Fed’s dual mandate has been remarkably constant. As a result, policy has evolved very predictably in line with communications on behalf of the consensus. The skittish, market-obsessed, and flip flopping Fed story fits the facts quite well also, and support for this story can often be stitched together out of structurally flawed Fed communications. In principle, outsiders could see through this. But many market participants cling tightly to the idea that the Fed is market obsessed, reflexively rejecting what is, in fact, a simpler story that fits the data at least as well.[4] As for the media, it is unfortunate, but perhaps not surprising, that the Greek drama is enthusiastically covered to the near complete exclusion of steady, predictable outcome.
I hope this barebones sketch is sufficiently intriguing that some readers will stick around for the supporting posts.
Notes:
1. I won’t repeat the full argument here, but one example is Bernanke’s June 2012 statement that the taper would (if the jobs market progress continued) start later that year and end around mid-year 2013. The taper started in December and purchases were trivial by mid-year, ending in October. The slight delay relative to the baseline calendar was due to a brief tactical pause when the jobs data briefly appeared to falter. [back]
2. Most of the relevant material will become public along with the FOMC transcripts 5 years after the fact. [back]
3. This “19” should, in these posts, be read as “however many of the full complement of 19 members are in place at any given time.” Of course, for many years, at least 2 governor slots have been empty. [back]
4. As I’ll argue more fully in coming posts, a main difference in the way the high-drama and low-drama stories account for the facts we’ve observed is that in the low-drama story it is no accident that ex post the Fed has delivered a policy consistent with what was laid out in advance. In the high drama story, the fact that policy evolved pretty much as stated on behalf of the consensus, I suppose, is just how the flip flops happened to net out. [back]