Communicating Monetary Policy at the Zero Bound
In a speech today at the Council on Foreign Relations, Boston Fed President Eric Rosengren described challenges central banks face in communicating about monetary policy when short-term interest rates are close to zero.
"The reaction to the discussion of a possible reduction in the Fed's asset purchases appears to have had an outsized impact on long-term rates," said Rosengren. Long-term rates are still about 100 basis points higher than they were at the beginning of May.
Contributing to the rise were communications from Fed officials indicating that if the economy were to improve as they expected, it might be appropriate to reduce the central bank's monthly purchases of Treasury and mortgage-backed securities sometime in the fall.
"The fact that the possibility of small future changes in policy could elicit such large movements" shows that central bank communication can be a powerful tool, but "an imprecise and unpredictable instrument in terms of its impact on long-term rates."
While monetary policy should be data driven, "saying that we will rely on all available data series, and that we will respond to news in the data…probably provides less clarity and guidance than much of our audience desires," said Rosengren. "A data-driven policy that also considers the risks to our forecasts can be difficult to communicate."
Furthermore, "it is likely that caveats about conditionality, data-driven policy, and responsiveness to incoming data are likely to receive far less attention" than calendar dates, whether stated or inferred.
Rosengren pointed out that alternatives for policy communication also come with challenges. For instance, committing to altering policy on a particular date could lock policymakers into inappropriate policy actions, should conditions change. Or, tying policy to a particular economic variable risks that the variable will cease to be as a good proxy for overall conditions - for example if the unemployment rate drops due to workers leaving the workforce rather than from an increase in jobs.
"We have more learning to do on how best to communicate monetary policy during uncertain and unprecedented times," said Rosengren. "However, the most important thing we at the Fed can, and should, communicate is that the policies we are setting are consistent with our goals - our mandate - for maximum employment and price stability."
Regarding his own recent vote on policy, Rosengren said "We saw weaker economic data emerge between the June and September FOMC meetings, and a higher than anticipated jump in market interest rates," along with the risk of fiscal disruption. So "in my view continuing the asset-purchase program was warranted, and fully consistent with" the Fed's mandate.