Disagreement is bubbling up at the Federal Reserve as dueling growth and inflation risks pull policymakers in different directions. If you think the debate seems fiery now, just wait until the third quarter, when recession may be at the nation’s doorstep.
Last week offered a taste of the brewing divisions. On Tuesday, Federal Reserve Bank of Chicago President Austan Goolsbee, a dovish first-time voter on the rate-setting committee this year, called for “caution and watchfulness and prudence” in monetary policy after the failure of two banks in what seemed like an implicit endorsement of a pause to rate increases. As he put it:
Given how uncertainty abounds [about where] these financial headwinds are going, I guess I think we need to be cautious. We should gather further data and we should be extra careful about raising rates too aggressively until we see how much work the headwinds are doing for us in getting inflation down.
A few days later, Fed Governor Christopher Waller delivered a speech emphasizing how rates had to go higher because inflation “is still much too high.” Here’s Waller:
Because financial conditions have not significantly tightened, the labor market continues to be strong and quite tight, and inflation is far above target, monetary policy needs to be tightened further. How much further will depend on incoming data on inflation, the real economy, and the extent of these tightening credit conditions.
There was a marked difference in the balance of the two speeches that illustrates the emergence of two distinct worldviews. Goolsbee focused on the risks to growth (the words “financial stress” appeared 10 times), while Waller zeroed in on stubbornly high inflation.Never mind the careful caveats in both sets of remarks; for a mild-mannered pair of Fed policymakers, this came off as quite the war of words. Expect the dissonance to grow from here — and bond market confusion along with it.
Monetary policy, of course, has been relatively straightforward for the past year. The US had the worst inflation in 40 years, the labor market seemed to be historically tightand consumer spending was strong. Under those circumstances, any central banking novice knows that you’re supposed to raise the policy rate, and that’s exactly what the Fed did relentlessly (and almost unanimously) over the past 13 months, with only two dissents since March 2022.
Now, the US is heading toward what many economists — including the Fed’s own staff — suspect will be a recession in the latter half of the year. The US banking system is on shaky ground after the collapse of Silicon Valley Bank and Signature Bank, and lenders are expected to tighten credit conditions. The commercial real estate market faces a dangerous wall of debt maturities this year and declining property values. And consumer delinquency, which had been extraordinarily low, is starting to rise again in categories such as auto loans. All of this is a recipe for Fed infighting, especially if economists are right about a “mild recession” — painful enough to put people out of work but not so deep initially as to extinguish inflation. Ultimately, a verbal fracas in plain sight would make Fed policy less effective, and Chair Jerome Powell should do everything in his power to make sure that doesn’t happen.
In decades past, the Fed didn’t have to worry about this cacophony of voices in its communications; it simply avoided communicating. Former Chair Alan Greenspan famously told a congressional committee in 1987: “Since I have become a central banker, I have learned to mumble with great incoherence; if I seem unduly clear to you, you must have misunderstood what I said.” It wasn’t until 1994 that the Fed even started putting out concurrent press releases with its policy decisions; before then, market participants mostly had to keep an eye on the Fed’s open market trading desk for signals. But since Ben Bernanke became chair in 2006, Fed officials have communicated frequently with the public. In principle, this is a positive development. Democratic societies should demand transparency from their public institutions.
Still, it sometimes feels like transparency overload these days, with Fed speakers just about constantly offering remarks at regional economic clubs, universities and on financial television shows. That’s not a problem as long as the policymakers are mostly on the same page. But when they’re not and the stakes are high, it could lead to self-inflicted wounds and a breakdown of the Fed’s transmission of policy.
In a 2016 speech, Chair Powell — then a Fed governor — played down concerns about the “cacophony problem.” He said that Fed speeches show the public that a diversity of views are represented on the committee, and that should be somewhat heartening to outsiders who disagree with its policy. Somewhat comically, Powell also proffered that those who are bothered by it should just stop “reading too much about the path of policy into all of this communication.” Here’s how he made light of this type of commentary:
Many of us enjoy getting out of the office to speak to outside groups. We appear to enjoy talking to print journalists, and some of us like going on television. With the proliferation of media of all kinds, there is a need for content, and we have been willing suppliers. In my view, these public appearances are mostly not about gaining leverage in a negotiation.
It wouldn’t be my base case, but maybe these speeches truly are just a fun little hobby, and all the apparent gamesmanship is in our heads. Either way, trillions of dollars can change hands over these speeches, and that’s not going to change anytime soon. Traders have to listen attentively and trade off the comments because their peers are doing so and they don’t want to miss out. In an environment like this, Powell might want to reevaluate the seriousness of the “cacophony.” If the Fed can’t speak with a coherent voice when it matters most, central bankers might be well advised to find a new form of out-of-office diversion.
When Bernanke ushered in the transparency push, it wasn’t all about accountability, of course. Policymakers saw “transparency” as a tool to wield more influence over longer-term market expectations. Car loans, single-family mortgages and corporate bond market rates all depend, to a large degree, on longer-term Treasury yields, not the short-term policy rate. To hold sway over the broad market, the Fed needed to manage policy expectations many years into the future. Bernanke did so in part by adding policymakers’ policy-rate forecasts to the Summary of Economic Projections and pledging to keep policy accommodative for a considerable time.
So is the message getting out of control? Not yet. On balance, it’s still pretty clear that the Fed, under the leadership of the moderately hawkish Powell,will raise rates by an additional 25 basis points to a range of 5% to 5.25% when policymakers meet May 2-3. But if the unity is already fraying along the edges, there’s a real risk that it will break down when the decision-making gets harder later this year. The Fed has never faced a duel inflation-growth conundrum quite like this in the transparency era. Policymakers can only control expectations when they coalesce around a coherent story and get markets to buy in. If not, they just end up fueling volatility, and that could make the “mild recession” that many economists fear worse than it needs to be.
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