“When I was at the Federal Reserve, I occasionally observed that monetary policy is 98 percent talk and only 2 percent action.” Ben S. Bernanke, Inaugurating a New Blog, March 30, 2015.
“I do not like them, Sam-I-am. I do not like green eggs and ham.” Dr. Seuss, Green Eggs and Ham, 1965.
Tomorrow, June 4, we will present our paper, Improving U.S. Monetary Policy Communications, as part of the Federal Reserve’s review of its monetary policy strategy, tools, and communications practices. This post summarizes our methodology, analysis and recommendations.
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Since the mid-1990s, the U.S. economy has been reaping the benefits of a credible commitment to price stability, including a communications framework that reinforces that commitment. Over the same period, both the level and uncertainty of inflation have declined (see here). It is against this backdrop that we look for further enhancements in the Federal Open Market Committee’s (FOMC) communications framework.
In doing so, we take the annual Statement on Longer-Run Goals and Monetary Policy Strategy as the foundation on which all other FOMC communications should be built. Were the FOMC to alter its strategy, such as introducing an “average inflation” target, the annual Statement is the natural place to make this change, and then to clarify and operationalize it using all the other communications tools.
To help identify areas with the greatest potential for improvement, we began with two dozen open-ended interviews of former policymakers, academics and market economists. In the course of these interviews, a number of topics surfaced so often that we judge them as essential (see following chart). Ranked by frequency, these are:
the central bank’s reaction function
uncertainties and risks around the expected path of policy
the “dot plot” in the Summary of Economic Projections (SEP)
transparency as a policy tool, and
addressing the general public.
In some cases, there was no clear consensus on how to proceed. For example, with respect to the “dot plot” showing FOMC participants’ policy rate projections, some respondents proposed to eliminate it, while others wished to augment it (see here).
Frequency of Topics Mentioned by Interview Respondents (Fraction of respondents)
Source: Interviews of 24 former central bank officials, academics and market economists in the first quarter of 2019. The allocation of responses by topic is based on the authors’ judgment.
Combining the interview responses with our own reading of published work leads us to three objectives that form the basis for our analysis:
simplify public statements, while conveying any divergence of views;
clarify how policy will react to changing conditions;
and highlight policy uncertainty and risks.
Simplify public statements. Reaching the broadest possible audience requires communicating in plain English. Because the post-meeting statement conveys the FOMC’s key decisions, it is among the Committee’s most important communications tools, and should be accessible to a broad audience. The statement as we know it is actually a recent innovation: only since May 1999 has the Fed released a statement immediately following every meeting. Over time, the length and complexity of the statement have waxed and waned, but on average, it requires a four-year college education to read (see chart below).
Readability of the FOMC Statement, 1994-May 2019
Note: The size of the bubbles indicates the number of words in the statement. The dashed horizontal line denotes the average grade level of 16.6: a college senior (or a post-graduate student).
Source: Davis and Wynne (2016) and authors’ calculations using a readability calculator.
Aside from complexity, communication by multiple FOMC participants can foster confusion. Some of this reflects the necessary communication of differences in views—for example, when officials articulate the rationale for dissents. Nevertheless, it is in the collective interest of FOMC participants to encourage what Alan Blinder refers to as “group accountability.” This means establishing practices and norms that make communications more effective.
We identify several useful practices that we believe can further improve public statements, including the following four:
Encourage each participant to explain the decision of the Committee—supporting it if they agree, or explaining their dissent if they do not.
To foster group accountability, use the first-person plural (“we,” “our,” “us”), except when clarifying disagreements or explicit dissents.
Focus comments more on the rationale for recent decisions, on the prospect for key policy drivers—such as inflation and economic growth—and on the justification for dissent, and (absent an agreed policy rate commitment) less on the likely future path of interest rates.
While taking financial conditions into account, resist becoming overly concerned with the immediate financial market reaction to FOMC decisions and statements.
Clarifying how policy will react to changing conditions. When growth, unemployment, inflation, and other financial conditions deviate from what they expect, how will policymakers react systematically and predictably? In the language of monetary economics, what is their reaction function? When observers understand the FOMC’s reaction function, they speed the response to prospective actions in financial markets and in the economy. Away from the effective lower bound, widespread understanding of the reaction function is likely to deliver sufficient stimulus to the economy. At the effective lower bound, communications itself becomes a policy tool, helping to make credible “low for longer” policy rate commitments, as the opening quote from former Chair Bernanke suggests.
Increasing transparency regarding the reaction function is a demanding task. To see why, note that a change in the policy rate could be the consequence of either changes in the perception of current or expected future financial and economic conditions, or changes in the desired response to these conditions. Moreover, even if every FOMC participant acts systematically, when perspectives on the economy diverge, new developments can shift the Committee consensus in complex ways.
Highlighting policy uncertainty and risks. Communicating uncertainty about the likely evolution of the economy and the resulting policy path is essential (see our earlier post). Officials may be concerned that effective communication of uncertainty will underscore how little they actually know. However, it is important that the public understand the challenges of setting monetary policy—above all, that there is always considerable uncertainty and that a key feature of effective policy is a willingness to entertain differing assessments, correcting errors quickly as new information arrives. Highlighting the scale of uncertainty in good and bad times also helps improve policy at the effective lower bound, when there is naturally less uncertainty about the policy path.
Recommendations. We propose that the Fed review its communications framework in light of these three objectives, updating the various components so that all are based on and expressly linked to the Statement on Longer-Run Goals. As examples of this, we take a careful look at two key elements of FOMC communications: the post-meeting statement and the Summary of Economic Projections (SEP). We propose simplifying the statement and converting the SEP into a concise Inflation Report to be released with the Chair’s press conference immediately following the quarterly SEP meetings.
Simplified post-meeting statement. To address the general public and their elected representatives, as well as financial markets, the FOMC must speak in plain language. A simple and easily readable post-meeting statement will, in our view, increase credibility and accountability, improving the effectiveness of policy.
Readability indexes, like the Flesch-Kincaid Grade Level measure, suggest that shorter sentences composed of words with fewer syllables make documents easier to read. For example, Dr. Seuss’ Green Eggs and Ham (see the opening citation) uses only one three-syllable word (“anywhere”) and has a Flesch-Kincaid grade level appropriate for pre-school (-1.3). We don’t go that far. Instead, we recommend aiming for the reading level of a high-school senior (grade 12)―well below the long-run average of 16.6 (see dashed line in chart above). If the effort at simplification leads to some loss of precision in the statement, policymakers can offset this by using other communications tools (such as the press conference and the minutes) that address narrower audiences.
With this objective in mind, we examined recent post-meeting statements. To simplify them, we recommend focusing on three core elements:
the statement of the decision, including votes for and against;
the rationale for the decision, including the reason for dissents;
and a discussion of uncertainties and risks.
For each of these, the FOMC should include information on both the policy rate target and the balance sheet, including any commitment that they may wish to make. Our resulting alternative statements (for December 2017 and March 2019) have a readability grade-level average of 11.6 (a high-school junior) versus an average of 16.4 for the original statements.
Converting the SEP into a concise Inflation Report. Inflation reports are valuable tools. Central banks produce them both to focus public expectations formation on stated long-run objectives and to discipline pre-meeting preparations and post-meeting communication of the people involved in the policy deliberations. Of course, the FOMC does not engage in the consensus building associated with the production of a comprehensive Inflation Report like that of the Bank of England. And, in light of governance considerations, it is unlikely to do so in the future.
However, the SEP contains most of the components needed for a concise Inflation Report. We disagree with those who would discard the SEP, having written earlier about the value of its median projections for furthering the understanding the FOMC’s reaction function (see Dot-ology). Instead, in an immediate release of the Inflation Report version of the SEP, we propose that the FOMC highlight a set of fan charts for the policy rate, inflation, unemployment, and growth that include historical projection errors (these are now released with a three-week lag). Furthermore, we recommend that this release include the matrix that links the participants’ projections for growth, inflation, unemployment, and interest rates (now released with a five-year lag), as well as the participants’ names (now released with a 10-year lag).
By giving prominence to the fan charts, the new Inflation Report would highlight the range of uncertainty around the median projections. We also suggest including other figures (currently included with the minutes) that show the distribution of FOMC members’ perceptions of the uncertainty and risks in their projections for GDP growth, unemployment, and inflation. Were the FOMC to add a brief qualitative description of the current state of the economy, of the sources of uncertainty and risk, and of divergences in views, we expect that the resulting report would become a natural focus of public discussion by FOMC participants between quarterly meetings.
Importantly, such an Inflation Report need be neither long nor complex. We take the Bank of England’s “visual summary” as a model. The May 2019 version has 729 words, 4 charts and a Flesch-Kincaid grade level readability score of 7.7 (see here). Our draft concise FOMC Inflation Report, based on the March 2019 SEP and meeting minutes, has fewer than 730 words, with a Flesch-Kincaid grade level score of 9.7.
Highlighting the inevitable uncertainty in the outlook for the economy and policy, and presenting a concise Inflation Report at the Chair’s press conference, would help shift the public discussion. Rather than responding with false precision to questions about the SEP median path of policy rates, a focus on the uncertainty associated with the outlook would help to align the Chair’s public comments with the risks that the FOMC perceives.
The same goes for the public comments by FOMC participants. If the Governors and Reserve Bank Presidents were to focus their communications on explaining the sources of uncertainty, this would help counter any excessive public attention to the SEP median projections. And, should one or more participants explicitly dissent, their comments can bring to light whether these disagreements arise from differing assessments of the current state and likely evolution of economic and financial conditions, or from different views about the appropriate policy responses to those conditions.
Conclusions. We applaud the Federal Reserve’s achievements in establishing a credible communications framework that helps secure price stability and maximum sustainable employment. We base our suggestions for incremental improvements on three guiding objectives: simplify public statements, while conveying any divergence of views; clarify how policy will react to changing conditions; and highlight policy uncertainty and risks.
The examples we propose—to simplify the post-meeting statement and publish a concise Inflation Report—are squarely in line with these objectives. The first seeks to broaden access to the Committee’s most important written description of its actions, of the rationale for those actions, and of its ongoing concerns. The second aims to focus greater attention on the inevitable uncertainty involved in policymaking and on the Committee’s commitment to correct errors quickly and transparently as new information becomes available. We believe that implementation of these changes will add further to the effectiveness of FOMC communications in promoting the ultimate objectives of price stability and maximum sustainable employment mandated by the Federal Reserve Act.
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Note: The video recording of the June 4 Federal Reserve conference session on communications is available here.