The Fed's Other Big Power
Originally published on Fri September 14, 2012 1:06 pm
We think of the power of the Federal Reserve as the power of money. After all, the Fed is the one institution that can create U.S. dollars out of thin air.
But recently, Ben Bernanke has argued that the Fed has another, critical power: the power of words. And when you're the chairman of the Fed, a few words can go a long way.
In a speech last month, Bernanke said this: "The Federal Reserve will provide additional policy accommodation as needed to promote a stronger economic recovery ..."
After the speech, the TV business channels went wild, suggesting that big Fed action was coming soon.
But how does the magic work? How do a few cryptic words get everyone so worked up?
Joe Gagnon, a former Fed economist who now works for the Peterson Institute for International Economics, pointed to a single word in that one sentence: "stronger"
Saying "stronger" recovery is "making it clear that this recovery we've had to date is not strong enough, in their view," Gagnon said. "That's a indication that they feel the need to do more."
It's subtle. But sentences like that provide a signal to investors so they don't get surprised when the Fed wants to do something big. When trillions of dollars are at stake, surprise is bad.
And as cryptic as it might sound sometimes, the Fed is now more clear and direct than its ever been in its history.
Just 20 years ago, the Fed didn't even tell the public what it was thinking or doing. People had to watch money moving in the markets to figure out what the Fed had decided to do.
These days, Ben Bernanke says that communication — just talking, really — is one of the most powerful tools he has.
For instance, last year rather than just say they were keeping interest rate low, the Fed said it expected to keep the rate low for years.
"That was actually a very powerful impact on the markets," says Randall S. Kroszner of the University of Chicago, a former member of the Fed's Board of Governors. "And if you looked at the futures markets for the short term interest rate, they actually moved quite a bit."
The Fed will release a new policy statement this afternoon. Fed officials, if they want to, could simply extend that promise of low interest rates again. But if Bernanke really wants to test the power of talking, he could give a very detailed description of the plans for the future.
The Fed could promise to keep interest rates low until, say, unemployment comes down to a certain level, or until the economy is growing at a certain clip.
It would be a dramatic departure from the more subtle hints and coy language its used in the past. And there is a lot of debate in the economics world about whether or not it would work. But Bernanke may decide that extraordinary times call for extraordinary words to match.
RENEE MONTAGNE, HOST:
There is plenty of debate over what the Fed is expected to do today. The Fed won't reveal that decision until this afternoon, yet somehow they make sure that no one will be too surprised when that decision is announced. Robert Smith from our Planet Money team takes a look at how the Fed can use a wink and a nod and a few words to shape the economy.
ROBERT SMITH, BYLINE: You got to wonder: How does a guy who talks like this...
BEN BERNANKE: Our tools, while they are non-standard, still can create more accommodative financial conditions.
SMITH: Ben Bernanke: How does he inspire stock markets with that voice? Well, remember that speech that Bernanke gave in Jackson Hole? It wasn't recorded, but, here, I'll read you a key sentence: The Federal Reserve will provide additional policy accommodation, as needed, to promote a stronger economy.
Sounds unremarkable, until someone explains the code. Joe Gagnon was an economist at the Fed. Now he works for the Peterson Institute. And Gagnon noticed that Bernanke didn't say he wanted to promote a strong recovery. Instead, Bernanke said stronger.
JOE GAGNON: To promote a stronger economic recovery, making it clear that the recovery we've had to date is not strong enough, in their view. That's a strong indication that they feel the need to do more.
SMITH: And doing more has a technical name at the Fed: quantitative easing, QE, a way of getting more money moving and lowering interest rates. The financial news channels, Fox, Bloomberg, CNBC, they understood the code.
(SOUNDBITE OF NEWS MONTAGE)
UNIDENTIFIED MAN #1: He definitely appears to tee it up yet again with a...
UNIDENTIFIED WOMAN: Ira Jersey from Credit Suisse says expect QE3...
UNIDENTIFIED MAN #2: Look, we know that market is wired for quantitative easing. The question is...
SMITH: Believe it or not, Bernanke's cryptic communications are actually the most direct the Fed has been in its history. If you go back even 20 years ago, the Fed was almost silent. If it wanted to influence the economy, it just moved money around. It didn't tell people.
Now Ben Bernanke gives speeches and press conferences. It may be in code, but it still has a real advantage over the old way. Instead of moving all that money around, Bernanke can just tell people he's going to do it. For instance, last year, rather than just holding interest rates down, the Fed said it expected to keep rates low for years to come. Randall Kroszner, an economist at the University of Chicago, says essentially by saying it out loud, it came true.
RANDALL KROSZNER: That was actually a very powerful impact on the markets. And if you looked at the futures markets for the short-term interest rate, they actually moved quite a bit.
SMITH: Kroszner was on the Federal Reserve board a few years ago, and he says that he learned that this trick only works if people believe that the Fed is ready to back up its talk with action. You can't just promise anything and then not do it.
KROSZNER: That's one of the reasons why sometimes things aren't as crystal-clear as they could be, because circumstances can change. It has to be a little bit more nuanced.
SMITH: There are, though, economists who argue that this is not the time for nuance, that the Fed should be even more open than it is. Rather than hint, the Fed should essentially make specific promises. Bernanke could say in order to promote a stronger economy, we will do whatever it takes to get the unemployment rate under, say, 6 percent. Or he could say I won't stop until the economy is really booming at this rate. Few expect the Fed to go that far today. It may be opening up, communicating more, but Fed habits change slowly. Robert Smith, NPR News. Transcript provided by NPR, Copyright NPR.