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Too Much Talk

Phil Kernen

OVER THE PAST 25 years, the Federal Reserve has become more transparent than ever. Much of this is the result of political pressure. Still, the Fed has taken it further, believing greater transparency to be a good thing in helping 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 Fed is nominally independent but must answer to Congress, which can change the rules under which it operates or dissolve it altogether. For the first 60 years, Congress granted a great deal of latitude to the Fed, which communicated as little as possible, believing that transparency made policy less effective. 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 the Fed’s policymakers rejected repeated requests to explain themselves publicly.

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 even kept transcripts of its deliberations. When the Fed rebuffed Congress’s request for those transcripts to be released regularly, Congress threatened to legislate again. The Fed eventually complied by releasing a post-meeting statement and the meeting transcripts themselves, after a lag.

Over the next decade, the Fed took steps toward greater transparency, augmenting the disclosures required by Congress. Self-mandated communication grew by leaps and bounds following the 2008 financial crisis, when traditional monetary tools proved far less effective and were quickly cast aside in favor of new approaches.

Many of these new monetary tools relied on verbal guidance from the Fed to help set public expectations. This 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, following a long debate about inflation that had started in the mid-1990s.

But a turning point came in late 2018. For two years, the Fed had been slowly raising interest rates. Fed Chair 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—and thus interest rates would potentially be raised further.

Stock markets and President Trump registered their displeasure at his remarks. 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%. 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. Reflecting that pressure, the Fed ushered in a series of interest rate reductions in 2019, even before the onset of the pandemic in 2020.

We now sit nearly two years into the pandemic. The U.S. economy is expanding modestly due to growing consumer demand, with supply chains that can’t keep up. The Omicron COVID variant is the current challenge. Others will follow. Fiscal policy is uncertain and inflation has taken root, forcing the Fed to react.

The transparency, which 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 the Fed’s policymakers are working on a meeting-by-meeting basis.

Their public commentaries, interviews and speeches don’t help clarify matters. They’re thinking aloud and trying to develop their views in a public forum. They can’t tell us where rates will be six to 12 months from now. We are in uncharted waters, and Fed officials have no better idea than anyone else.

The Fed must meet the politically mandated transparency required by Congress. Beyond those minimum expectations, however, it’s time for the Fed to walk back some of the communication methods adopted over the past decade. In being transparent, sometimes you can say too much and cloud the message you’re striving so hard to clarify.

Phil Kernen, CFA, is a portfolio manager and partner with Mitchell Capital, a financial planning and investment management firm in Leawood, Kansas. When he’s not working, Phil enjoys spending time with his family and friends, reading, hiking and riding his bike. You can connect with Phil via LinkedIn. Check out his earlier articles.

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