The problems with the Federal Reserve's planned transparency

4 January 2012

Last night we received the minutes from the December meeting of the Federal Open Markets Committee which is the policy making section of the central bank of the United States. There were few, if any, grand insights into the US economy but there was in my opinion an insight into the mindset of central bankers in these times and this is of interest and indeed concern because they operate (or perhaps interfere) in so many spheres and markets right now. Also the matter they discussed is something which has bothered me for some time.

The FOMC has been telling us this for some time now: '...participants turned to a further consideration of ways in which the Committee might enhance the clarity and transparency of its public communications.'

In itself this seems a laudable enough objective although informing people in plain clear language might be considered a way of doing this!

What does the FOMC intend to do now?

'The SEP (Summary of Economic Projections) will include information about participants’ projections of the appropriate level of the target federal funds rate in the fourth quarter of the current year and the next few calendar years, and over the longer run; the SEP also will report participants’ current projections of the likely timing of the first increase in the target rate given their projections of future economic conditions.'

The obvious first point is that the plan to communicate clearly has struggled over the first hurdle at best has it not? Oh dear. However the plan is to tell people what FOMC members think US short-term interest-rates will be for the next few years.

The fundamental problem with this

As Earth Wind and Fire put it:

"Take a ride in the sky
On our ship fantasise
All your dreams will come true right away"

My issue with this as a concept is that virtually nobody will take any notice. This is a rather fundamental problem for a concept which to have an impact requires people to take note of it and then act on it! Also it is an odd time to introduce it as is there anyone who expects an interest-rate rise in the United States any time soon? So what will be gained by telling us this explicitly.

In addition there is another problem which is that FOMC forecasts are far from omniscience. If we look at the ones from early 2011 we see forecasts of 3.5/4% economic growth for 2011 which was way too optimistic. So there is a danger that rather than inspiring more trust in the central bank a sequence of incorrect forecasts would be likely to reduce trust and transparency rather than raise it.

Furthermore the construction of the FOMC poses a problem for this. Each year four reserve bank governors retire by rotation and are replaced by four others and this can lead to quite a change in likely policy moves. For example, this has just happened as the three “dissenters” to further expansionary policy have rotated off the FOMC to be replaced by group who may have one possible dissenter in Jeffrey Lacker of the Richmond Fed. So imagine the concept of one set of plans for interest-rates finding policy being set by a group with a different set of plans! I cannot see that improving transparency at all. It could quite easily make it worse.

Comment

This move to my mind illustrates what has happened to central bankers, they have become addicted to announcements and cannot stop even when they have little or nothing to announce. Step by step they have become more like politicians and it is my opinion that this trend needs to be reversed.

In addition as I review the changes in the membership of the FOMC that have just taken place I am left with the view that substantial policy action is much more likely in 2012 from the FOMC simply by the change of members. The house band “Benny and the Inkjets” has some new enthusiastic members ready to play some of Ben Bernanke’s favourite songs.

Some can benefit from knowing the future

News has emerged overnight that the wife of the Chairman of the Swiss National Bank Kashya Hildebrand allegedly purchased some 500,000 Swiss Francs worth of US dollars some 3 weeks before her husband announced a 1.20 ceiling for the Swiss Franc against the Euro. Within a month she had a 10% profit on this, so people can perhaps benefit from knowing how central banks will act……

I am not saying that I know that Kashya Hildebrand did anything wrong but I am saying that this sort of thing should not be allowed as it debases the credibility and perceived honesty of a central bank’s actions if it happens. In another form this looks like insider trading and Ms. Hildebrand should give the profits to charity in my opinion and the rules of the SNB should be tightened up.

Oh an investigation has taken place and the SNB has cleared its chairman of any wrong-doing. Perhaps it could save itself the trouble by simply banning investments and trades in instruments it influences or in this case sets…

More from Mindful Money:

The FOMC is living in a fantasy land whose dangers are highlighted by Hungary and the Euro Zone

US Federal Reserve to publish interest rate forecasts

Fed seeks more transparency to calm investors