To improve Fed policy, improve communications

Since May 2021, we have criticized the Federal Reserve’s lagging response to surging inflation. In our view, both policy and communications were inadequate to address the looming challenge. Early this year, we argued that the Fed created a policy crisis by refusing to acknowledge the rise of trend inflation, maintaining a hyper-expansionary policy well after trend inflation reached levels far above their 2% target, and failing to articulate a credible low-inflation policy.

Against this background, we commend the FOMC for its recent efforts. Not only is policy moving quickly in the right direction, but communication improved markedly. In particular, despite the increasing likelihood of a near-term recession, Chair Powell made clear that price stability is necessary for achieving the second part of the Fed’s dual mandate. We suspect that the combination of the Fed’s recent promise to make policy restrictive, along with its improved communications, is playing a key role in anchoring longer-term inflation expectations.

In this post, we focus on central bank communication and its link to policy setting. By far the most important goal of communication is to clarify the authorities’ reaction function: the systematic response of central bank policy to prospective changes in key economy-wide fundamentals—usually inflation and the unemployment rate.

To anticipate our conclusions, we argue for two changes to the FOMC’s quarterly Summary of Economic Projections to better illuminate the Committee reaction function. First, we encourage publication of more detail on individual participants’ responses to link individual projections of inflation, economic growth, and unemployment to the path of the policy rate. Second, we see a role for scenario analysis in which FOMC participants provide their anticipated policy path contingent on one or more adverse supply shocks that present unappealing policy tradeoffs (for example, between the speed of returning inflation to its target and the pace at which the unemployment rate returns to its sustainable level)….

Talking about Tapering

In May, we argued that the FOMC needed to communicate its contingency plans for what they would do should the recent inflation pickup prove more stubborn than its members expect. Such transparency makes it more likely that financial markets will respond to incoming data rather than to policymakers’ actions. By clearly laying out their reaction function, central bankers can avoid disruptions like market taper tantrums.

In June, the FOMC began to remove the self-imposed communication shackles designed to encourage “lower for longer” interest rate expectations and address inflation risks more openly. Indeed, as the above citation from Chairman Powell indicates, at their June meeting, policymakers began to lay the groundwork for scaling back their large-scale asset purchases (LSAPs).

In this post, we start by highlighting how recent Fed communication (which reveals appropriate humility about inflation projections) has helped avoid a market tantrum so far. Along the way, we discuss the various means that FOMC participants have used to express their changing views about the timing of interest rate increases (“liftoff”), even as they make clear that tapering their asset purchases will come first….

Has the U.S. Distribution of Wealth Worsened?

Wealth inequality in the United States is obvious to everyone. The Federal Reserve’s triennial Survey of Consumer Finance (SCF) documents the glaring and persistent divide between rich and poor, confirming that ownership of financial and real assets in the United States has been highly concentrated for decades (see our earlier post). The most recent 2016 estimates suggest that the top 10% of the wealth distribution own nearly three-quarters of all marketable assets, with the top 1% owning more than half of that. And, Saez and Zucman (SZ) estimate that the U.S. distribution has been getting worse, with the top 1% share of marketable wealth rising by more than 10 full percentage points since 1989.

But, as Catherine, Miller and Sarin (CMS) recently highlight, adding in the present discounted value of Social Security benefits (net of taxes) to construct a more comprehensive measure of wealth alters these patterns. First, according to CMS’s estimates, the share of marketable wealth in total wealth has plunged by more than 18 percentage points since 1989. Second, over the past three decades, the top 1% share of total wealth has risen only modestly, while the share owned by the top 10% has declined somewhat.

In this post, we highlight the CMS results, and decompose their changes in total wealth shares into two parts: the changes in marketable and Social Security wealth shares accruing to each group, and the aggregate decline over time of marketable wealth as a share of total wealth. We show that the latter dominates the overall trend in this more comprehensive measure of inequality….

Improving U.S. Monetary Policy Communications

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.

Commentary

Money, Banking, and Financial Markets