Influencing Economic Expectations
Looking at the Crisis from the Other Side of the Coin
If you have been following my articles , I have strongly advocated that the Congress approve the rescue plan proposed by Hank Paulson and Ben Bernanke. I won’t rehash all of the reasons why I think this must happen, but suffice to say, our financial system needs liquidity to be stabilized and that’s what this bailout is all about. You can read my other previous comments around the political ramifications, as well as responses to some of the claims by the opponents in this situation. But, now it appears the bailout could happen, and indeed, I think it will. The Senate approved the bill last night, and assuming the House doesn’t get caught up chasing their tales like they normally do, then hopefully we can start moving forward with resolving this crisis by the week’s end.
With that said, I’d like to address one of the biggest criticisms that I have heard people mention when opposing the bailout package, and this is probably the only real opposing criticism that I believe has merit. Many commenters to me personally and here at Redstate have indicated their frustration as to the lack of communication from the Fed and Treasury Dep’t throughout this crisis. A number of people on both sides of this issue have been less than impressed with the monetary policymakers’ inadequate information and guidance as to the details related to this situation and the bailout package.
What most general Americans (meaning people not associated with economics or finance) talk about lack of communications, what they mean is that they wish Bernanke and Paulson would have gone on the media circut, explaining every detail (real and perceived) of the bailout plan, similar to what a political official would do.
Fortunately, monetary policymakers are not elected politicians and the process of monetary policymaking is much different from the work that the elected folks do on the Hill. I have often spoken about how the monetary policymaking process should not be up to voters, because it is too complex and there are too many systemic vulnerabilities to let politics guide such a critical component of our economic competitiveness. As such, you will rarely see a monetary policymaker going from studio to studio speaking with the talking heads about what Section II of the legislation means, and you certainly won’t hear them speculating about any unforecastable effects of monetary policy, because the risk of uncertainty involved with such antics could have drastic effects on the markets.
You see, politicians can go around spouting off stupid comments to anyone under the sun and all it really does is make them look more ignorant. However, if you have the Chairman of the Federal Reserve making wonton comments about inflationary policy, the markets will (not maybe) react to that, and often times the reaction has a negative impact on the economy and more importantly, consumers’ pocketbooks.
With that said, communications does play a critical role in the monetary policymaking process. Indeed, thoughtful and strategic communications from the Fed and Treasury can lead to the make or break of specific policies, especially policies such as a rescue plan that has a direct impact on the efficacy of economic growth in the near term.
The role of communications in monetary policymaking has received a significant amount of attention in the last two or three decades, as economists have begun to realize that the free movement of information (regardless of quality and/or accuracy) through the internet and other mainstream media channels, can have a distinct impact on economic expectations. Indeed, a key role of the central bank (e.g., the Fed) is to manage inflation and setting inflation expectations is a critical component therein. As such, a core principle of influencing expectations is effectively communicating inflation policies and targets (in an inflation targetting regime, e.g., the EU, UK, etc) throughout the economy. The more consumers are informed about inflation, the less uncertainty will be involved, thus reducing volatility throughout the markets (in regards to monetary policy at least). Moreover, the more effective monetary policymakers are at influencing expectations, the less disinflationary work there will be for unemployment to do, thus another major concern for the economy (e.g., unemployment) can be effectively managed (see the Phillips Curve for more information).
Alan Blinder, the renowed Princeton economist, who also served as an economic advisor to President Clinton, published a paper with his co-authors earlier this year, titled “Central Bank Communication and Monetary Policy: A Survey of Theory and Evidence.” In the paper, the authors review much of the previous research conducted on the topic of communications on behalf of the central bank as an effort to implement more successful and effective monetary policies. It is very interesting in light of the chain of events we have experienced over the last couple of weeks, but the lack of communications around the specific bailout package is probably the least concern when it comes to the lack of effective communications from monetary policymakers throughout this entire crisis. These problems can be traced back to monetary policy from 2007 and even before them, where inadequate communication through various channels and policies contributed to the expansion of this crisis.
I know it’s easy to play the role of Monday morning quarterback here, which I have criticized many for doing throughout this crisis, but my focus here is not to criticize policymakers, because quite frankly, I think most of them, especially Ben Bernanke have done a great job managing the economy through this crisis. We probably should be in a lot worse condition right now than we actually are, and if we let the politicians have their way, we definitely would be worse off. But, despite the gloom and doom that we’ve been hearing (even from me on occasion) and the challenges we’re facing from Wall Street to Main Street, the resiliency of our economy has really been proven throughout this crisis.
Nevertheless, I think this is another take away lesson that can be learned from this crisis, in that even though more effective communication from monetary policymakers would not have prevented the crisis from taking place (the dynamics were overwhelming, to the point where communications could not have prevented the inevitable), I believe the connection between communications and the economic fallout from monetary policy has definitely been realized. And, I have to think that if improved communications became a higher priority for monetary policymakers, perhaps the amount of political butchering that will inevitably take place on the Hill can be minimized.