⏳ Reading Time: 3 minutesThis week we wanted to talk about interest rates and how the Federal Reserve (Fed) communicates its interest rate policy. At a time when everyone believes that “more is better” when it comes to information, the new Chair of the Fed, Kevin Warsh, and others favour a different approach.
Over the past twenty years or so, the US Federal Reserve has communicated quite extensively with investors – in speeches, press conferences and regular economic forecasts. This so-called policy of “forward guidance” was intended to give investors a pretty clear idea of what the Fed intended to do in the future. The idea was that this would help to anchor expectations for interest rate policy.
In recent years, there’s been some pushback – most notably from the new chair of the Fed. In fairness, Warsh has been sceptical about the approach for some time. The argument is that telling everyone what you’re going to do in the future makes it harder for you to change your mind, even when you should.
Critics of forward guidance typically refer to the period of 2021-2023 to support their case. Inflation spiked following the Russian invasion of Ukraine, and the critics argue that the Fed moved too slowly to change its stance and hike interest rates – in part because it had initially argued that inflation would prove transitory. Critics believe that kept inflation higher than it would otherwise have been and damaged the credibility of the Central bank. Some say that the policy meant that investors spent too much time trying to understand how the Fed would interpret data, rather than thinking about how the economy was behaving. Warsh wants investors to “play the ball, not the referee”.
