Warsh Turns Down the Volume on the Mood Music of Monetary Policy
Fed Chair Kevin Warsh offered some guidance for Wall Street and the financial press on Wednesday: stop looking for clues from the Fed about the path of interest rates.
Speaking at a central banking conference in Portugal, Warsh stuck by his guns when it comes to refusing to provide so-called “forward guidance.” At some points, Warsh appeared to be teasing those who are demanding guidance.
“At my press conference, I said we’re not going to give forward guidance because we’re meeting in six weeks,” Warsh said. “I have an update for you.”
Had he changed his mind on forward guidance? Nope. The update was that the meeting is now just four weeks away.
When the moderator of the panel—CNBC’s Sara Eisen—pressed him on whether a rate hike would be on the table at this month’s meeting of the Federal Open Market Committee, Warsh joked that “Sara is trying to get me to break this rule” about not providing guidance. “She’s going to fail.”
For more than a decade, Warsh has argued that the Fed had gone overboard when it comes to giving the market a narrative about its own outlook for interest rates. In a speech last year, Warsh made it clear that he thought the time for forward guidance had come to its end. “Forward-guidance – a tool rolled out to great fanfare in the financial crisis—has little role to play in normal times. Moving markets with rolling Fed incantations is tempting, but unhelpful to the Fed’s deliberations, and ultimately, to its mission. The central bank should find new comfort in working without applause and without the audience at the edge of its seats.” Warsh said.
The New Central Bank Consensus
Although the U.S. financial press and some Wall Street analysts are clearly annoyed by Warsh’s stance, he’s hardly alone in this view. One of the first remarks on the panel from Christine Lagarde, the chief of the European Central Bank, was a reminder that the ECB has also abandoned forward guidance. She added that her biggest regret as a central banker was that in the past she felt bound to act in accordance with forward guidance the bank had provided.
Instead of forward guidance, the ECB now provides “framework guidance,” Lagarde explained. That is, the ECB will inform markets about “how we come to our monetary policy stance,” the data the bank takes into account, the indicators it watches, and the intellectual process involved in its decisions.
“We have found common cause,” Warsh said in response. “I liked her when we first met twenty years ago, when she was finance minister. After that answer, I love her…President Lagarde’s answer on forward guidance — I couldn’t have said it better myself.”
The practice of providing forward guidance emerged from the challenge of attempting to ease financial conditions further when the Fed’s policy rate was already up against the “zero bound” and could not be reduced further. The idea was that the Fed could bring down longer-term rates by talking the market into believing that it would keep the policy rate low for longer than the market thought it would and that it would risk higher inflation, if necessary, in order to keep providing monetary stimulus to the economy. The Fed needed to “credibly promise to be irresponsible,” in Paul Krugman’s memorable phrase.
As the years stretched on and interest rates rose above zero, however, the Fed kept up the forward guidance routine. The justification shifted to the idea that it was necessary in order to prevent unwanted volatility in financial markets and to avoid excess uncertainty that might be a drag on the economy. Alternatively, the Fed’s forecasts of its own actions were sometimes presented as being important to controlling inflation expectations. This shifting rationale suggested that forward guidance had taken on a life of its own, becoming a ritual that had outlived its rational purpose.
Of course, big changes like this are going to meet resistance. Old habits die hard, as they say. At the end of the panel, Eisen pressed Warsh on the question of whether he is providing markets with enough information about the Fed’s “reaction function”—what data will cause the Fed to make what kind of decision on rates. Warsh pushed back hard.
“It is said in recent weeks, well, we need to know more about your reaction function. If I look at trigger-pullers—people making decisions in the bond markets, in a range of markets—volatility is not up. It’s down. Yields aren’t up, they’re down. Inflation expectations are down. So I hear this, as if people don’t understand. I think they actually understand quite well,” Warsh said.
It’s sometimes said that the Fed’s job is to take away the punch bowl just as the party is getting going. Warsh has taken on another task: turning down the mood music of monetary policy.
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