The FOMC minutes released yesterday report that,
In contrast, a few noted that the actions taken by several foreign central banks in recent weeks to increase monetary accommodation likely had helped mitigate downside risks to the global outlook. Nonetheless, many participants indicated that the heightened global risks and the asymmetric ability of monetary policy to respond to them warranted caution in making adjustments to the stance of U.S. monetary policy.
This ties in with my January blog post on the asymmetric ability of policies:
“Understanding the possible asymmetric effects is key to determining a policy’s effectiveness. Or in clearer terms, policies often work well when the economic environment looks up, but may be ineffective when the economy is down. A pre-determined laundry list of factors to monitor and guide the decision may be instructive, rather than a hodgepodge of excuses made up a week before central banks meetings.”
Apart from the asymmetric effectiveness of policies, another feature would be the diminishing returns to scale. Just like the overuse of antibiotics, policies that manage exuberance work less and less well every time they are applied.
Recently, I watched a show on food technology that conducted a few experiments on how we taste food. Apparently, whether we taste the strawberry ice-cream for what it is depends on the colour of the ice-cream. Just by changing the colour from pink to light blue can confuse us as to its strawberry flavour. Alternatively, listening to a higher pitch sound while eating makes the taste of dark chocolate more vibrant as compared to listening to a low frequency sound, which makes the taste duller.
Times like this put forward guidance and the need for clear communication by policymakers center stage in order to maintain credibility and sustain anchoring. Consequently, the next insight for policymakers should be that just like food tastes, the message communicated may not necessarily be received without alteration. Instead, it is often coloured by preconceived ideas as well as perception of the economic and financial environment. The Grandmaster level of central bank communication is to anticipate this and tailor the messages accordingly.
This paragraph from the FOMC minutes is striking,
A number of participants judged that the headwinds restraining growth and holding down the neutral rate of interest were likely to subside only slowly. In light of this expectation and their assessment of the risks to the economic outlook, several expressed the view that a cautious approach to raising rates would be prudent or noted their concern that raising the target range as soon as April would signal a sense of urgency they did not think appropriate.
I have heard before that the law does not have to be fair, but rather, have the appearance of fairness. I guess the act of raising rates too does not have to actually be timely, but rather have the appearance of being timely.
The minutes continue,
Relative to the December SEP, almost all participants marked down their projections for PCE price inflation in 2016, observing that declines in energy prices since the end of last year and continued strength in the dollar were expected to impart additional downward pressure on inflation this year.
Thus, if inflation is not an immediate issue and expectation of rates remain low for longer, then what should the Fed prioritise?
An interesting suggestion is for the Fed to help bolster global stability. I have even come across an article promoting that the Fed become the global ‘lender of last resort’. This of course, is nonsense. It is not in the Fed’s mandate to maintain global financial stability, and for a good reason – a ‘global Fed put’ is the last thing the whole world needs. It might help stability in the short run but will foster instability in the long run.
If one is looking for more global stability for the markets, then for the low hanging fruit we should look at the communication skills of the PBOC. When China is too often quoted as the source of instability for the global markets, then clearer communication from the country wouldn’t hurt – despite of, or maybe because of – its unconfirmed and doubtable numbers. Just like Yellen is synonymous with the Fed and Draghi with the ECB, the PBOC as well, needs a ‘face’, preferably one that speaks the Queen’s English and gives entertaining announcements. Answering questions from the press and strategically disseminating information reduces speculation. Imagine what a difference that would make!
It wouldn’t hurt either for the PBOC to have a playbook to hand on a variety of possible economic and financial crisis. Indeed, it is ever more crucial for the PBOC to form sophisticated strategies on how to build up its credibility. Muddling through “as it comes” is an embarrassment. This cannot be an option for one of the world’s largest economies that has been accused of destabilising the global economy over and over again .