I googled 'Fed Minutes' this morning and the first hit was this headline, Futures Flat Ahead of Fed Minutes. It is such a shame we must scour the Fed Minutes in order to find a hint of direction in our current monetary policy. Scott Sumner, Nick Rowe and Lars Christensen have several terrific blog posts on the subject the Federal Reserve's communication policy. They call for a Chuck Norris style central bank, where markets react to the directly communicated 'threats.' The thinking being that if a central bank is credible and clearly a communicate a policy target, then the markets will do the heavy lifting and facilitate the change in the expected variable (inflation, NGDP, r, etc). The beauty is that if the fed is credible, they likely won't even have to carry out on their threat, just like any reasonable person would run away if Chuck Norris announced in five minutes he would be back to round house kick you into the upper atmosphere.
I am skeptical about Ben Bernanke's ability to use the the communications channel of monetary policy effectively, not because a Chuck Norris style would not be effective, it would, but because Bernanke's choice of policy instrument tells us little about the expected direction and stance of monetary policy. It all comes down Bernanke's countenance to use interest rates and the credit channel of monetary policy. Here is the Nov 2 statement:
"To support a stronger economic recovery and to help ensure that inflation, over time, is at levels consistent with the dual mandate, the Committee decided today to continue its program to extend the average maturity of its holdings of securities as announced in September......The Committee also decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that economic conditions--including low rates of resource utilization and a subdued outlook for inflation over the medium run--are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013"
My bold, this is exactly why the markets eagerly await the fed minutes. This style of communication tells us very little about monetary policy. In the 1970's the federal funds rate was at record high levels. Today it sits at all time lows for the foreseeable future, but does anyone make the claim that monetary policy was tighter in 1978 then it is today? That is exactly why solely focusing on interest rates as a stance for monetary policy is a mistake.
Let's say tomorrow the PIIGS bond yields soar in anticipation of a Eurozone break up. If Bernanke's only communication mechanism is interest rates, what more can he say that will prevent the collapse of domestic demand from failing as well? The answer is not much as we have already hit the zero lower bound, his best case scenario is to say we will hold interest rates low indefinitely and try and push the yield curve down lower. But without alternative measures taken, that will do little to stop the decline GDP as the rush for liquidity passively tightens monetary policy.
It is unlikely however, that Bernanke will allow a deflationary collapse. Throughout his reign BB has shown little problem using unconventional monetary policy to prevent deflation, but if Bernanke were to choose a more suitable target and clearly communicate his expected monetary policy, these unconventional QE's and twists would not be necessary in the first place.
P.S. I think Bernanke views interest rates as the native tongue for his central banking language and he is worried that if he switches to a foreign language, either he will misspeak or the markets won't understand. The response to that is as long as you have a clear target and are fully committed to meeting your target, the markets will start speaking your language.
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