Today Janet Yellen came before the Senate Banking Committee to answer questions following last week’s announcement that the Fed will keep the Federal funds rate steady in light of May’s devastating job numbers. While the big media headline focused on Yellen echoing the Bank of England’s warnings against Brexit, the biggest take away may be Yellen’s tacit admission that the Fed’s consistently poor track record of projecting rate increases has crippled its credibility in financial markets.
Yellen’s confession was the result of questioning from Senate Banking Chairman Richard Shelby, who asked whether the Fed’s “frequently incorrect predictions of interest rate increases” have damaged the effectiveness of the Fed’s forward guidance. For those unfamiliar with the term, “forward guidance” is a communications technique employed by the Fed as a policy tool. As the Federal Reserve’s website explains:
When central banks provide forward guidance about the future course of monetary policy, individuals and businesses will use this information in making decisions about spending and investments. Thus, forward guidance about future policy can influence financial and economic conditions today.
While this may seem like standard practice for new Fed watchers, it’s important to note that forward guidance is a relatively new weapon in the Fed’s arsenal and seen by some as one of the lasting legacies of the Bernanke-led Fed.
But forward guidance only works if people believe the signals the Fed is showing and, as Senator Shelby noted, Yellen has become the Chairman Who Cried Wolf when it comes to raising interest rates. So when pushed on the issue, Chairman Yellen downplayed the notion the Fed was offering forward guidance anymore anyway. As she put it:
We used forward guidance in the aftermath of the crisis in order to help market participants understand how serious the crisis was and how long we thought we would continue to maintain the federal funds rates. We are not relying very much on forward guidance.
The problem is that, until today, Yellen has given no indication that the Fed was not in fact “relying very much on forward guidance.” In fact, the Fed continues to release forecasting tools such as its “ dot plot”, which illustrates the predictions of Federal Reserve officials on where interest rates will be in the future.
Since the Fed has not given any indication that it was no longer in the business of offering forward guidance, market analysts writing for the Wall Street Journal still thought that the Fed’s word meant something because the Fed had not given any indication that it was no longer offering forward guidance. The closest anything came to such a signal was an incidental comment by one Fed official in an interview . He simply mentioned that “he’s getting ‘increasingly concerned’ about giving forward guidance through those projections.
Today’s global monetary regime is guided by what Jim Grant calls “a PhD standard,” and much of this relies on the credibility of central bankers and their dedicated officials. As such, it is not a surprise that Yellen took the approach of dismissing the importance of forward guidance altogether during today’s hearing, rather than admit the truth – the Fed’s terrible record of forecasting has destroyed its credibility to the point that its word no longer means anything.
Because of that, it has lost a policy tool it once thought was valuable.
Other notes from today’s hearing:
- Senator Sherrod Brown, leading Democrat of the Banking Committee, spent much of his opening remarks blasting Donald Trump and Ted Cruz for their support of the gold standard. Brown blustered that "we don’t know if it is just a bad idea, or a really bad idea. But as one University of Chicago professor put it, “Love of the [gold standard] implies macroeconomic illiteracy.”
While there is reason to doubt the sincerity of both Trump and Cruz for the politically popular gold standard, it’s amusing to see politicians still appeal to the authority of Chicago School economists in the face of the financial crisis.
- A common line of questioning from Democratic Senators, including Elizabeth Warren and Bob Menendez, involved the lack of demographic diversity among Federal Reserve officials. Jonathan Newman has already tackled the absurdity of this criticism, which is just another form of the Marxian polylogism Mises criticized in Human Action.
- Senator Pat Toomey offered some of the strongest attacks on the Fed’s low interest rate policy, pointing out that it does not create “new wealth, good or serves – but shifts the timing of economic activity” and that it is “damaging economic growth going forward.”
Toomey, who obviously hasn’t bought in to the Fed’s alleged wisdom, offered the best “forward guidance” yet.”
