Central banks are unquestionably more transparent than in the past. But Jerome Powell’s speech at Jackson Hole last week was yet more proof that transparency does not mean clarity. And the void that the Fed’s ambiguity leaves comes at a price.
Despite the array of Fed officials lining up to say that the time for tapering the QE program is drawing close, Powell continued to keep his options open on the precise timing. Though he acknowledged that in his opinion “the substantial progress test had been met for inflation”, he remained more ambiguous about the employment test. The upshot is that we still don’t know with certainty if the taper will begin this year.
The speech follows a familiar pattern of vagueness from the Fed. It publishes unemployment projections over the short and longer-term. But it won’t define maximum employment, with Powell recently conceding: “it’s very difficult to be precise about it”. With no end point, no one knows when the Fed will reach its destination.
The Fed’s inflation objectives are arguably even more mysterious. Last year, the Fed shifted to an average inflation target. But they haven’t defined the length of the window over which the average is calculated. They’ve also remained vague about the degree to which inflation will be allowed to undershoot and overshoot the 2% target, admitting that it may be different for every policy voter. Well, yes, quite. But don’t point people in the direction of something if you’re not willing to tell them what it is.
Meanwhile, the Fed’s analysis of why inflation has increased so much this year has also lacked substance. Their mantra is that it is mostly due to transitory distortions created by the nature of the pandemic and the reopening of the economy. But what exactly is meant by the term transitory? How can transitory wage and price pressures be distinguished from persistent pressures? And if the acceleration in inflation is due the economic re-opening they were already expecting, why have their forecasts been so off base? We’re left to guess the answers.
Ambiguity creates optionality for central banks. It also comes at a price.
There are good reasons why the Fed would want some ambiguity. If they’re so clear that all investors draw the same conclusions then trades get crowded and markets become more volatile when the Fed inevitably changes course. More clarity would arguably make investors hang on to every word that the Fed says even more than they already do. Equally, the Fed’s decisions are conditional on a future that it cannot be certain about, so a degree of uncertainty is essential.
But if the Fed isn’t even being clear about what it is targeting and how it will behave under different circumstances then they just create layers of uncertainty over other layers of uncertainty. That can force investors into a cottage industry guessing game about the policy path, leading to more rather than less volatility and wasted resources.
When a company reports its results it can’t precisely forecast all of the variables that affect its future earnings. But it does have to present a coherent business strategy if it wants investors to value its shares appropriately. There aren’t too many CEOs who make a virtue out of keeping their investors guessing.
The guessing game is particularly pernicious because of who the Fed is. They discharge decisions that influence the world’s premier risk free asset and, as a consequence, how every other asset in the world is valued. The importance of clarity and cost of ambiguity is greater than in any other part of the financial system. Ambiguity creates optionality for central banks. It also comes at a price.