B, B', and B''
In advance of each FOMC meeting, Board staff sends the Committee a set of policy alternatives in the form of alternative drafts for the post-meeting statement. Typically, there are 3 options – A, B, and C. B is the option the Chair prefers and around which he or she has built or is seeking to build a consensus (one Governor jokingly said she always assumed “B” was for “Bernanke”). A and C are meant to span the range of views on the Committee—A more dovish and C more hawkish—and aren’t really meant to be serious alternatives. Instead, if there are multiple live options, they are labelled B and B’ and rarely B’’.
The options the staff sent out this week for the September meetings might have had a B’ or even a B’’. As I noted a couple weeks ago, there is a good case for now adding forward guidance conditional on average inflation outcomes. There is a pretty widely held view that the Committee’s recent monetary policy framework changes won’t really change how they will actually conduct monetary policy. Forward guidance that says they will keep rates at zero until average inflation is above, say, 2? percent would make the implications for actual policy much more concrete.
However, no less than five Reserve Bank presidents have implied in recent weeks that additional forward guidance is not needed because the market “…understands that we’re not planning on raising rates anytime soon.” (Rosengren). I think they are wrong for two reasons. First, as noted above, I don’t think the market really understands how policy will be different under the new framework and the guidance would help. Indeed, a canonical reason to provide forward guidance is to fix a market misperception about the central bank’s reaction function. Second, they are forgetting the (Sarah Bloom) Raskin (a/k/a Woodford) critique – it isn’t helpful if you convince the market that the situation is so awful that you will stay at zero for a very long time, you have to convince the market that you will stay at zero for so long that you are going to make things better. Specifically, guidance like “economic conditions are likely to warrant [a funds rate near zero] at least through…” (August 2012) is less helpful than guidance like “…will remain appropriate for a considerable time after the economic recovery strengthens.” (September 2012).
In the September 2012 meeting, then Governor Raskin argued forcefully for language that did not perpetuate a message of anticipated weakness. She was actually arguing that the Committee adopt conditional guidance, something they didn’t do until December, although when they did, they preserved the “considerable time after” language. Indeed, September 2012 was one of the rare meetings when there was a B, B’, and B’’; B’’ included conditional guidance (see pp. 17-27 of Tealbook B).
Gov. Raskin’s statement in support of conditional guidance at the September meeting bears quoting at length because it is so relevant for the current situation:
The calendar date, as we have heard, is working against us. It is communicating that we are continuously downgrading our assessment of the future. Why not, instead, show households, businesses, and markets what we are looking for in terms of particular economic outcomes? Why not offer a sneak preview of what we need to see before we begin contracting? With such a preview and credible delivery, households and businesses and markets figure out how we are going to react. Providing that window, and keeping the panes of that window clean, reduces volatility and pessimism about our commitment to support a recovery. In mitigating this volatility and pessimism, as argued by President Kocherlakota and others, we maximize the effectiveness of the other actions being contemplated.
But we have been down this road before, so we ask, why now? Why move to forward guidance that is dependent on the economic outlook sooner rather than later? We should consider forward guidance that is dependent on the economic outlook sooner rather than later because there could be costs to putting this off. The primary cost is the permanent downward shift in expectations that becomes more probable the longer we wait. The longer we put off these contentious decisions, the greater the probability that we let stand the perception that there is a new, lower, slower trajectory of economic growth that we are comfortable with; the greater the probability we let stand the perception that the FOMC doesn’t adhere to the statutory directive of a dual mandate; the greater the probability we let stand the perception that we act forcefully when we are off the price-stability mandate but not when we are off the maximum-employment mandate; and the greater the probability we let stand the perception that 2 percent is a ceiling.” (Transcript of the September 2012 FOMC meeting)
While there have been several Reserve Bank Presidents implying that no change in guidance is necessary at the upcoming meeting, I suspect that there are several Board members that favor a change in guidance. Indeed, the Presidents could be seeking to prevent the markets from becoming too certain there will be a change in forward guidance, forcing the Committee’s hand.
The Chair’s job is first and foremost committee management, and it looks like Chair Powell may have a big job to do in coming days. This seems like an especially bad time to have dissents, so I’m sure he is working hard to forge a consensus before the meeting begins. If there are two or three “Bs”, that makes his job more difficult. Changes to the asset purchases (or at least the justification for the asset purchases) could also be in the mix. I’m eager to see what emerges Wednesday.
As always, please feel free to share this email. Comments, questions, or discussion welcome.