Experts doubt oracular value of Federal Reserve statements

April 30, 2014

There was much discussion during Tuesday’s “Monetary Policy: Forward Guidance on the World’s Central Banks” panel on how much guidance the Federal Reserve should provide in its forecasts. Brian Sack, senior vice president and co-director of global economics at the D. E. Shaw Group, took the view that the Federal Reserve should offer additional details concerning the Federal Open Market Committee’s forecasts to make them “more informative.” Sack said an adjustment to short-term interest rates is on the horizon and urged the Fed to communicate better on this in the lead-up to potential rate hikes.

Michael Feroli, chief U.S. economist at JPMorgan, and Athanasios Orphanides, a former governor of the Central Bank of Cyprus, questioned Sack’s view. Feroli was concerned that the market would just gravitate toward the forecasts, while Orphanides said, “It is not a good idea to try and make precise statements about the Fed funds rate.” He added that as long as the Fed explains what the outlook for inflation and other metrics are, “they don’t need to be giving us point estimates of where the Fed funds rate will be.”

Feroli warned against putting too much weight on Fed statements. “It’s a bit of a risk,” Feroli said, if institutions rely too much on the communication.

The panel considered whether a credit bubble is emerging and whether that can be attributed to the Federal Reserve’s monetary policy. Cliff Noreen, president of Babson Capital Management LLC, said the factors preventing a credit bubble at this point outweigh the forces that would favor a bubble. Corporate profits are rising, Noreen said, and the volume of riskier payment-in-kind issuance, while growing, is “way more controlled.” The quality of issuance is better and defaults remain low, he said. However, Noreen said the market is overdue for a credit correction of 25 to 100 basis points.

Questions from the moderator, David Zervos, managing director and chief market strategist at Jefferies LLC, also focused on the divergence between central bank policies. Specifically, the U.S. and United Kingdom are slowly moving away from accommodation, whereas the European Central Bank and the Bank of Japan are pursuing quantitative easing policies. Orphanides explained that the euro zone has gone through a “tragic depression” over the past several years due to the political mishandling of the crisis. “It’s a political crisis that the Central Bank cannot correct – the ECB has been caught in the middle.”

The ECB should have expanded alongside the Fed, but instead find themselves in a “lowflation” environment where nominal income is not growing. This brings into question the sustainability of debt for larger European Union economies, he said.

On the similarity between current European Central Bank policy and past policies from the Bank of Japan, Orphanides pointed out that ECB monetary policy “has been unnecessarily tighter that it should have been.” He added, “We have seen what the consequences of overly tight monetary policy has been for Japan. It’s scary to project those consequences for the EU.” The difference between the two policies, however, is that the Bank of Japan has never had to deal with the political dynamic that the ECB has to face, he said.

Sack applauded the recent aggressive moves from the Bank of Japan and the open communication of its recent regime shift, but noted that the ECB has been reluctant to take such an approach.

Orphanides also stated his worry about any central bank “operating with stars.” The “follow-us, we’re the Fed” mentality “may take us into the realm of astrology rather than science,” Orphanides warned. That being said, Zervos was quick to point out that a 1930s-vintage light fixture at the entryway at the Federal Reserve’s Eccles Building in Washington, D.C., includes a Steuben glass ring depicting the signs of the zodiac.