Ryan Avent’s initial enthusiasm for the Fed’s new communication strategy is beginning to wane. Avent began to lose his new-found Fed religion after reading Lorenzo Bini Smaghi’s critique of the Fed’s new policies. Here is Smaghi:
[I]f the objective of price stability is defined over the longer term, communication becomes more complex. In particular, the link between the inflation forecasts and the policy decision is unclear. What should market participants derive from a published inflation forecast above the two per cent target in the long run (but not necessarily over the next two years)? Should they expect a tightening to take place? And when? The long run is not a “policy-relevant” time horizon and thus has little value for those attempting to understand the central bank’s next moves.
Welcome to the club. As I have been arguing the past few weeks
, the Fed’s new communication strategy is at at best white noise to the market and at worst worst a quagmire of confusion. For example, how should one interpret the fact that FOMC’s forecast did not just push out the horizon for increasing the federal funds rate but also lowered the expected growth rate for real GDP in 2012 and 2013? Is the FOMC signalling additional monetary stimulus or a weaker economy to come over the next two years? Some observers noticed long-term nominal interest rates dropped after the official launch of the policy last week and concluded the Fed was signalling more monetary stimulus. The fact that long-term real interest rates also declined suggests that the market interpreted the policy as signalling lower expected growth. So much for a policy that is supposed to add clarity and stimulus through expectation management. There is a better wa
y to this.