These three front-row people are central bankers. They are apparently saying funny things. We wish we could hear. And hang out with Haruhiko Kuroda. Photo by Andrew Harrer/Bloomberg via Getty Images.
So unemployment is now under 6%, finally falling into the Fed's "longer run" forecast range. But labor force participation, involuntary part-time workers and other less mainstream stats are still in the doldrums, which some say means there is a lot of slack in the labor market, which is jargon for "people aren't working or earning as much as they could/should be." Apparently this-and a similar situation in the UK-puts Fed head Janet Yellen and BoE chief Mark Carney in a pickle, because their rate hike decisions are apparently not cut and dry. And apparently this means we all need to parse every single one of their statements for clues into what they'll do, because if they get it wrong the expansion could go poof and we will all need to brace for impact. I'm going to ignore that second part because my wonderful colleagues covered it earlier today here, and concentrate on the first part. Namely, the notion that we can divine future policy from central bankers' words. If you have a magic decoder ring and fully functional crystal ball, perhaps you can, but for us nonmagical folk, it's an impossible task, and we're all best off not trying-and not putting much weight on analyses that claim they've cracked the code.
The punditry always goes into overdrive trying to interpret the opaque vagaries in the FOMC's policy statements and Fed members' public comments, but there isn't much point. Forward guidance doesn't tell you what the Fed will do. It just tells you what the Fed wants you to think it will do. As the Bernanke Fed's lengthy debate over a single adverb in their September 16, 2008 policy statement shows, they choose words based on how they'll make people feel. They aren't statements of intent or promises to act. They're just words to make us all feel safe and sound knowing Fed people are paying attention and know they need to do things at some point (not that this should inspire any confidence at all-the Fed is often wrong). The "substance, sizzle, or marketing," as Bernanke put it in September 2008, are what matter. It's much the same for the BoE, ECB and other central banks.
Don't believe me? Consider how Yellen's messaging has evolved since she took the helm in March. In that meeting, she made a splash by changing the Fed's guidance on the fed-funds rate. Since 2012, the FOMC's statement said the rate would stay in its 0-0.25% range "well past the time that the unemployment rate declines below 6-1/2 percent." But by the March meeting, unemployment was down to 6.7%, and according to the meeting minutes, "all members judged that, as the unemployment rate was likely to fall below 6 ½ percent before long, it was appropriate to replace the existing quantitative thresholds at the meeting. Almost all members judged that the new language should be qualitative in nature," and that's what they delivered. The new guidance read: "The Committee continues to anticipate, based on its assessment of these factors, that it will likely be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends..." (I truncated the inflation-related mumbo jumbo to make your life easier.)
Now, let's look at how Yellen has told us to interpret that clause-particularly the words "considerable time" over the past few months.
March 19: So, the language that we use in the statement is "considerable" period. So, I-you know, this is the kind of term-it's hard to define. But, you know, it probably means something on the order of around six months or that type of thing. But, you know, it depends.
June 18: So what I want to say, the guidance that I want to give you, is that there is no mechanical formula whatsoever for what a "considerable time" means. The answer as to what it means is, it depends. It depends on how the economy progresses.
September 17: I do not think we have any mechanical interpretation that applies to this. It, of course, gives an impression about what we think will be appropriate, but there is no mechanical interpretation. ... And it is important for markets to understand that there is uncertainty, and this statement is not some sort of firm promise about a particular amount of time.
So to recap, it went from six months-ish to no mechanical formula to whatever. Now, this is actually sort of a good thing. Central bankers have historically tried to be as vague as possible! Alan Greenspan made it an art form, always speaking in riddles that even Yoda would envy. He once quipped, "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." Early on, Yellen made the classic boo-boo of being too specific, running the risk of backing the Fed into a corner. She wised up and got vague. No more corner. If you needed proof the Fed doesn't want you to take its words too literally, there it is.
The award for ultimate flip-floppy guidance, though, goes to Carney. He is living, breathing, walking, talking proof central bank guidance isn't carved in stone on Mt. Sinai. On August 7, 2013, shortly after he took over as BoE Governor, Carney issued the bank's first-ever forward guidance, which said: "The MPC intends not to raise Bank Rate from its current level of 0.5% at least until the Labour Force Survey headline measure of the unemployment rate has fallen to a threshold of 7%." BoE forecasts pegged that milestone sometime in late 2016. But by February 12, it was nearly there, so the threshold was scrapped in favor of some noncommittal fuzzy rambling. And a lot of waffling ensued.
February 12: Look this-we're in a situation where there is notable spare capacity in the economy. We've put figures around that. We've built up that assessment of spare capacity through the labour market where we think it principally lies. We'll all watch the evolution of that, and we'll be commenting on that. We think that we can draw down that spare capacity further before there's any need to adjust Bank Rate, and I would say that medium term forces, the types of forces that are weighing on the longer term equilibrium, medium term equilibrium level of interest rates are unlikely to dissipate any time soon.
May 14: The exact timing of the first adjustment of Bank Rate will be a product of the evolution of the economy. Today's not the day. There's additional slack that-wasteful space capacity that can be used up. I've outlined-we've outlined-I've outlined in my remarks, we've outlined in the Report, a series of things that need to happen to sustainably use up that slack. As we progress, we will get to a welcome moment where the economy is headed far enough back towards normal that there will be the first adjustment in Bank Rate. But that remains to be seen. It's a decision for another day.
June 12: There's already great speculation about the exact timing of the first rate hike and this decision is becoming more balanced. It could happen sooner than markets currently expect. (ED: At the time, markets expected the hike in May 2015.)
June 24: As the economy progresses, the time to normalise interest rates is edging closer, it's coming closer.
July 16, reflecting on the June 24 speech: We were concerned that markets were not reacting to a fairly long run of data that had been as expected, if not a little better, and there had not been a change in prediction for the first rise in interest rates. The only guidance that the new Monetary Policy Committee is now giving is around the expected medium-term path of interest rates, not the timing of the rate rise.
August 17: We have to have the confidence that prospective real wages are going to be growing sustainably [before we raise rates]. We don't have to wait for the fact of that turn to raise them.
September 9: Our latest forecasts show that, if interest rates were to follow the path expected by markets-that is, beginning to increase by the spring and thereafter rising very gradually-inflation would settle at around 2% by the end of the forecast and a further 1.2 million jobs would have been created. ... In other words, we would achieve our mandate.
September 25: With many of the conditions for the economy to normalise now met, the point at which interest rates also begin to normalise is getting closer.
So to translate: First, he said the hike would be a long way off, then sometime this year, then "just kidding, and we aren't going to give you any more hints," then sometime next year, now sometime nebulously soon. Flip, flop, wiffle, waffle. Markets aren't being complacent, sir. They've just learned not to take you at your word. (They may also have remembered history, which doesn't show rates hikes are automatically negative for markets, an article for a different day.)
Look, there is zero way anyone can know when rates will rise in the UK, US or anywhere else. Rate decisions are made by committee. They depend on a few human beings' feelings, ideologies and interpretations of a smorgasbord of economic data. We aren't in their heads-and frankly I wouldn't want to be-so we can't know what they're thinking or how they'll react to whatever economic data come out. All we can do is wait and judge the appropriateness of their next moves whenever they happen.
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