The Communication of US Monetary Policy is getting worse not better and the UK will have aircraft carriers without planes!

Friday was a day where a speech by a central banker was eagerly awaited as Ben Bernanke who is Chairman of the US Federal Open Markets Committee gave a speech on monetary policy. However I wish to take us back to one second before he gave the speech and I would contend that he and his colleagues had already made a mistake. This mistake is that everybody feels that they know what his policy is anyway and pretty much everybody expected a relaxation in US monetary policy on the 3rd of November when the FOMC meets next. In effect he has boxed himself in, imagine what would happen on the 4th of November if there was no action from the FOMC? What if economic developments turn out to be a little more favorable? One of the strengths of a central bank is its ability to surprise markets whereas this time round in a reversal of what I consider to be due process markets are driving the FOMC. Indeed the FOMC is facing the fact that it is chasing market expectations rather than driving them.

At a previous speech at Jackson Hole Ben Bernanke said the following.

A second policy option for the FOMC would be to ease financial conditions through its communication, for example, by modifying its post-meeting statement…………The Committee will continue to actively review its communication strategy, with the goal of communicating its outlook and policy intentions as clearly as possible

So one may at first wonder if Ben Bernanke is making what I consider to be a mistake deliberately. He specifically says interest rates in his speech but may have decided to adopt such a policy for all monetary measures. However in the same Jackson Hole speech he said.

A potential drawback of using the FOMC’s post-meeting statement to influence market expectations is that, at least without a more comprehensive framework in place, it may be difficult to convey the Committee’s policy intentions with sufficient precision and conditionality.
Actually he is raising another issue here in addition to my point of lack of flexibility for future decisions. He is suggesting that the FOMC may struggle to get its intentions over accurately and after his speech on Friday and a further one at the weekend by the President of the Chicago Federal Reserve Charles Evans that is exactly what is happening in my opinion.
What exactly did Bernanke say of significance on Friday?
There were two main elements in his speech. The first is in essence he plans to set a formal inflation target for the FOMC. To those who do not follow the minutiae this may come as a surprise but at this time part of the FOMC’s mandate is based on price stability which implies an inflation target of around 2% as opposed to the Bank of England for example which has an explicit 2% target which it is supposed to aim at. Unfortunately the Bank of England seems at this time to have re-interpreted its own mandate but this is a different matter. So here is an immediate irony for you the central bank with a 2% inflation target does not want it and the one which does not have it wants one! The answer to the irony is that both appear to want inflation higher. Just to complete the current mandate of the FOMC it is supposed to look at the wider economy and unemployment as well.
In the speech we got that he would be aiming at inflation of “2 per cent or a bit below” and that in his opinion “inflation is running at rates that are too low”. So I think that inflation targeting will be the new policy.
How will he do it?
This was less clear because in a section which at a football match might invoke the terrace chant of “you don’t know what you are doing”, Ben Bernanke then said this.

one disadvantage of asset purchases relative to conventional monetary policy is that we have much less experience in judging the economic effects of this policy instrument, which makes it challenging to determine the appropriate quantity and pace of purchases and to communicate this policy response to the public.

Although to be fair to football managers even the most incompetent very rarely admit they do not know what they are doing. However the crucial signal in the speech was this sentence.

 In particular, the FOMC is prepared to provide additional accommodation if needed to support the economic recovery and to return inflation over time to levels consistent with our mandate.

So additional accommodation is the new euphemism for more quantitative easing or what has been called QE2 and as I will be looking at aircraft carriers later in this article I wish to be clear that whilst both are expensive I feel that the monetary easing will be even more expensive in the long run.


If Mr. Bernanke feels that he has improved the FOMC’s method of communication then, sadly, he has yet another failure on his record. The debate at this time is not one of if but one of how much and on this we were none the wiser when he sat down. As I stated at the beginning of this article this is not a game I feel that central banks should play and now I can add another reason why not, they are simply not very good at it.

The first problem is that the FOMC speaks to a specialist audience and it speaks in a rather esoteric language to them so by the time this arrives at your average person I suspect they neither understand what is happening nor are they much interested. Mr.Bernake might claim that the fact that QE2 is expected is a success for the new policy but this could have been achieved more successfully by simply doing it could it not?

Charles Evans gives us yet another view on FOMC policy

The President of the Chicago Fed. gave a speech a day after Mr. Bernanke which was even more in favour of monetary easing as he gave a speech about price level targeting rather than the inflation level targeting suggested by Mr. Bernanke.

In my opinion, much more policy accommodation is appropriate today……………If you reach the conclusion that we are in a liquidity trap, or even near a perilous liquidity trap, more accommodation is not data-dependent or a close call……..A third and complementary policy tool would be to announce that, given the current liquidity trap conditions, monetary policy would seek to target a path for the price level. Simply stated, a price-level target is a path for the price level that the central bank should strive to hit within a reasonable period of time………..We should put this policy tool on the table and debate its suitability to the current situation in the U.S.

Contrary to what Mr.Evans suggests there are a lot of issues with this type of policy but in terms of establishing his position it would mean that the Fed. would aim to raise the price-level in the United States by some 8/10%. Then his policy would be the same as that of Mr. Bernanke. Or as he puts it.

Inflation would be higher than 2 percent for a time until the path was reattained.

So there you have it and there are a lot of implications from it but Mr. Evans is very sure as he describes such a policy as “nearly optimal”.


This policy of expectations management is not going very well is it? Only one day passed between one view from the Chairman of the FOMC and another more aggressive view from the President of the Chicago Fed. Now whilst Mr. Evans does not have a vote in November I believe that there are some on the FOMC who share his views. So here we have problem number one before you can communicate a policy you have to agree on it! This basic fact appears to have escaped Mr. Bernanke as he gave us policy option 2 at Jackson Hole back in August.

If we return to Mr. Evans’s speech I believe that there are a lot of holes. Regular readers will be aware that in the area of extraordinary monetary measures I believe you should be as clear as to how you will reverse them as you are about implementing them before you start. Here Mr.Evans’s proposal is full of holes.

My response is to continually fall back on the discipline of the state-contingent exit plan. A central bank exercising this policy would have to credibly convey to the public that this policy will end when the price gap is closed.

Only in the “thought-bubble” of a central banker could you say this let alone think it. When the time came to reverse the policy there would be all sorts of other pressures and the FOMC has shown itself to be weak, so Mr. Evans exactly how would you achieve this? Some may already be wondering if he ever intends to do this and to the extent that investors think this then the policy is failing before it has even begun.

Next we get the rather inconvenient fact that inflation figures are subject to revision. What happens if Mr. Evans turns out to have targeted the wrong price level? I wrote on the subject of US inflation indices back on July 2nd and indicated why I feel that its CPI measure is wrong and underscores the level of inflation in the US. We got some weak CPI figures on Friday with annual inflation at 0.8% on an annual basis and the so-called core index at 0.1%. The latest figures for the inflation measure used in Europe and the UK is by contrast at 1.8%. This is a complicated area as Mr. Evans is also looking at the Personal Consumption Expenditure Price Index and I feel that I have introduced quite a few concepts in one day so I will return to it in another update! However I would like to leave in your mind the thought that I have already seen quite a few articles championing proposed moves by the FOMC by people who seem to be unaware that there is some debate about the measurement of US inflation. I would not for example send a rocket to Mars without very careful calculations and being sure about what would happen, however not everybody is the same and I remember the mission from a year or two ago that crashed into it……

Yes Minister turns out to be prescient

I am a fan of the television series and books written on this subject as they were written 20/25 years ago and are as relevant now as they were then. They also manage to be very funny and let’s face it at a time like this a good laugh is beneficial for us all. I was reminded last night of the episode about a hospital which had no patients. Sir Humphrey Appleby who was the representative of the Civil Service advanced the view that it was the most efficient hospital in the UK,hitting all its targets mostly because it had no patients “who only get in the way” of a smooth-running hospital!

What reminded me of this was this from the BBC about the purchase of two new aircraft carriers for the Royal Navy and the emphasis is mine.

Meanwhile, Defence Secretary Liam Fox confirmed the carriers would be left without planes for a period because of cuts to the military budget in the Spending Review.

Perhaps they will be the most efficient carriers in the world without airplanes messing up their smooth operation….


8 thoughts on “The Communication of US Monetary Policy is getting worse not better and the UK will have aircraft carriers without planes!

  1. Hospitals without patients, carriers without planes, univeristies without students. Everything has been thought out to the last detail!

    • Hi Andy we do need genuine reform of our banking system but this proposal has weaknesses as well as strengths. For example in the first paragraph they state.

      “This system effectively provides a subsidy to the banking sector of up to £100billion each year – a subsidy that, one way or another, comes out of your pocket”

      If we taxed that then there would be plenty of money to fix things…..

      I am more in favour of starting reform of banking from the bottom-up rather than top down which is another way of saying that we will make progress I feel by increments rather than one “magic bullet”

  2. Thanks again Shaun. I thought Bernanke was being rather cautious in his language when talking of buying longer term securities/QE2. He knows there could be trouble ahead on exit. So, I thought his reference to an earlier speech was important, his July speech. There, he talks of tools to switch maturing debt proceeds to shorter-term securities, assets sales and draining the banking system of reserves. But, with your story on foreclosure as an example of risk, where do these clever ideas get us otherwise than a central bank acting as lender of last resort to the entire private sector.

    • This is surmise but I felt that Ben was pointing towards an increase in the amount the Fed was buying each month that is currently around US $25 billion in an expansion to QE-lite. However with the market response to this and the Charles Evans speech I would say that option number 2 that of communication needs a little,ahem,refinement to say the least….

  3. Is it possible that Bernanke has finally accepted that he does not know what to do next? Could it be that events are finally demonstrating there is no answer to a recession but to let it take its course?

    Of course Bernanke could never admit this because the enormity of so doing would result in a collapse so severe as to make the ’29 depression look like a walk in the park.

    Indebted as it is and in no shape to handle the effects of a so called double dip, the Fed must now see the additional risk of sovereign nations drifting off into gold rather than holding reserves in dollars.

    These are shaky times with three major currencies looking decidedly paper thin and the Chinese currency now starting to look decidedly fragie.

    Paper money has always relied on publics confidence and when that evaporates, do we see a run on a country rather than on a bank?

    Some Austrians have seen a gold price of six thousand dollars an ounce: they might in the future be accused of having been far too timid

    • Hi waramess,

      I fear you may be crediting Bernanke with much more understanding of the real situation than he actually has! I believe that his perceived position is only to attempt extrapolate the present ongoing advantage for his banking cronies to appropriate an increasing share of the available monetary value from taxpayers.

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