The Royal Swedish Academy of Sciences has a fantastic sense of humor. Hopefully, the award will lead Warsh to reconsider his crusade against guidance and transparency.
At a time when Federal Reserve Chair Kevin Warsh has turned central bank “forward guidance” into a banned phrase, the academy awarded the Nobel Prize in economics to Michael Woodford, one of the intellectual fathers of the practice, and Robert Hall, whose research on household expectations provided a foundation for Woodford’s later research.
As Woodford wrote in a later paper presented at the Federal Reserve Bank of Kansas City’s Jackson Hole Economic Policy Symposium in 2005, the transparency revolution brought broad benefits: In August 2011, the committee said economic conditions were “likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013. it did moved toward a target threshold in December 20212 Although the Fed didn’t take his nominal GDP suggestion exactly. With inflation above the Fed’s 2% target for six years running now, the challenges facing monetary policy today are vastly different today from those during the financial crisis, and that means guidance about the future should take a different shape.
He has repeatedly declined to provide an explanation of what the interest rate-setting Federal Open Market Committee might do in response to changing economic conditions, or what is known as the Fed’s so-called reaction function. Also, he has slashed the size of the Fed’s post-monetary policy meeting statements; shortened press conferences; floated an idea to reduce the number of times the Fed meets annually and while taking a dim view of the Summary of Economic Projections, which is the Fed’s anonymous survey of policymakers on their rate and economic forecasts, declining to participate himself. In Warsh’s view, the Fed can achieve the best results without explaining itself. But Woodford’s research shows that communication is essential to achieving success. As he once put it in an interview, effective central banking depends not just on making the right call, but “communicating about how you make it also matters. An effective communication strategy means that markets can immediately price in what policymakers are likely to do in response to a given macroeconomic development, helping reach a central bank’s intended results efficiently. It was a revolutionary sentence that Hall’s work on household expectations and Woodford’s on Fed communication made possible. Beyond the pure economic justification, transparency is about institutional survival. Time and again, central bank opacity has made the institutions targets of a skeptical public and opportunistic populists. Crucially, the Fed has protected itself — and its ability to set set interest rates to the long-term benefit of the American people — by opening itself up to the world. An open Fed is a more credible Fed that will find stronger societal support at a time when its institutional integrity is under attack by President Donald Trump.
For his part, Woodford said he had reservations about the specific form of that guidance. He said it was filled with “fine print” that gave the committee escape hatches, and preferred other “target criterion,” proposing at Jackson Hole in 2012 that the Fed consider a nominal GDP target.
Ever since he was tapped to lead the Fed earlier this year, Warsh has been adamant about the idea that the central bank should “stop talking so much.
