The U.S. Fed has a communication problem. That’s the essential takeaway from Bob Eisenbeis’ interesting analysis of the Fed’s June 19 policy announcement. In an attempt to speak to two different constituencies—investors and the public—it’s sending messages confusing to both. But more trenchant than this observation is Eisenbeis’ methodical deconstruction of the Fed’s policy rationale—and the conclusion that the Fed’s own forecasting does not support its pronouncements. Given that the global economy largely hinges on the Fed’s guidance, the inconsistencies could cost people everywhere a lot of money.
Eisenbeis is vice chair/chief monetary economist at Cumberland Advisors and former director of research at the Federal Reserve Bank of Atlanta. As he explains, Fed chair Ben Bernanke has, for example, posited an improvement in the U.S. unemployment situation for 2013 and significantly so for 2014 despite lowering growth projections for 2013. Furthermore, the 6.5% unemployment trigger the Fed has said will allow it to begin talking about ending QE won’t happen until 2015 under the Fed’s own most optimistic growth scenario, and yet Bernanke suggested in the announcement that tapering could come as early as this fall.
The immediate question is, why is the Fed saying something different from its own data?
I spoke to Eisenbeis to get more on his take. He told me he believes two explanations are at the root of the issue. One is that the Fed’s communication policy appears to have evolved separately from the forecast policy (which is bad). And two, forecasting is done four times a year, but meetings are held eight times, so the policy announcements may be out of sync with whatever internal forecasting has been done. He also pointed out that many of the reserve banks don’t use formal models for forecasting and that they base forecasts on “guessing.”
“The whole forecast process needs to be reassessed,” he said.
He recommends two solutions: one, a forecast for every meeting, which should force a return to modeling, and two, shortening the time horizons of the forecasts. “Markets don’t care about a forecast over a year,” he said. “They care about much shorter term horizons than that. And most of these models do forecasts on a quarterly basis. The GDP numbers come out on a quarterly basis and they should be doing forecasts on a quarterly basis and release those forecasts so that people can see the path [to the announced policies].”
Separate communication packages, one for investors and another for the public, would also be ideal, he said, because the two constituencies are concerned about different things.
However, while Eisenbeis’ point is valid, it doesn’t really address the elephant in the room: No matter how the Fed describes what it’s trying to do the only thing that is for certain is that it has simply run out of racetrack. (Eisenbeis did also say, “I think they’ve painted themselves into a corner that’s going to be awfully hard to get out of.”) Any reduction in Treasury debt purchases will push up interest rates independently of the zero interest rate policy because the Fed has been virtually the only buyer of the debt. To attract buyers to replace the Fed, higher rates will have to be offered. This will simultaneously increase rates throughout the economy (and incidentally reverse the deficit-reduction gains the government has lately been running). If the U.S. economy has been moribund at near zero interest, it will surely crater if rates go up from there. And it will take other economies with it.
The evidence can be seen in the reaction to Bernanke’s non-statement on June 19. It took just talking about *maybe* starting a cessation to quantitative easing, never mind actually beginning one, to send U.S. 5-year bond yields soaring by their highest amounts ever. Equity markets plunged.
The reality is there is in the U.S. no recovery in the real economy. The improvements touted in employment fail, for example, to take into account the fact that the labour participation rate has plunged and the quality of jobs that have been created are poor. Over the last five years there have been near zero wage gains for the broad middle of the actually employed, so its ability to afford rising prices—capital or interest—remains unexplained at best. The housing recovery is dominated by investors, not first-time home buyers and does not account for the massive (foreclosure) shadow inventory being held by banks, all of which artificially pushes up prices. Student debt and delinquencies are in fact worse today than they were at the start of the financial crisis, hobbling the ability of young people to participate in driving a recovery.
What is happening here is just sheer desperation on the part of the Fed, which is trying to talk down the markets while simultaneously reassuring everyone recovery is real and underway. Bernanke doesn’t dare admit it, but the hemming and hawing shows he knows the Fed has over-extended itself. And the markets, now thoroughly addicted to easy money, know it, too.
This is something no amount of communications refinement can fix.