Making (of) a Statement

By Jeffrey Snider

I am decidedly in favor of going back to the way it was twenty-five years ago. These constant communications from the Federal Reserve, designed to increase transparency, have accomplished the opposite. Alan Greenspan was made famous for first being an accidental genius (no, it wasn’t massive offshore monetary growth that made the Great “Moderation”, it was 25 bps moves one way or the other in the federal funds rate!) but more so he achieved celebrity for fedspeak.

This latter term referred to the “maestro’s” keen ability to string together often nonsensical terms that were purposefully nonsensical but were reported upon by a dutifully obedient media as if it was all golden wisdom received directly from the mouth of King Solomon. Ironically, it was Greenspan who fought the hardest against conducting monetary policy out in the open; the more he resisted with obfuscation, the more it made him a TV star (if little else).

We don’t know for sure exactly when the central bank switched to a federal funds target. The FOMC did so in what were by comparison the Dark Ages. I don’t mean that in the respect that the Fed simply acted in complete secrecy and darkness; rather, policymakers realized that after the seventies the monetary system had evolved in such a way that they could no longer define let alone measure money (missing money). How do you conduct monetary policy without money?

It’s clear that was one of the driving forces behind the push toward openness. When everything was simple, and M1 still meant something, you really didn’t need to explain yourself. In a world where you can’t even say why M1 is no longer appropriate, you better say something out in public. If you don’t you risk the public suspecting that you are, forgive me, pulling policy decisions directly out of your ass.

That’s what really happened, of course. But these official statements were meant to convey the idea that’s not what was going on behind closed doors. Monetary policy ceased being monetary in the seventies, so by the nineties it became the precursor to American Idol.

In February 1994, the federal funds target was 3%. That was, for the time, an extremely low level. The Great Inflation experience was still fresh enough (like the housing bubble is to us today) and so there were a great many concerns about it being so low. It was justified, in private, because of substantial fears over the S&L crisis. Greenspan didn’t want a large bank collapse to trigger another depression.

The arrival of recession in 1990 amplified their economic concerns of a bank-money-economy feedback. Starting in May 1989, the FOMC completely reversed course from previous “tightening”; federal funds that were targeted for 9.8125% then were brought down to 8.25% at the cycle peak in June 1990.

Once recession showed up, it’s like the Fed panicked; by its end the target was 5.75%. The economy, however, didn’t recover right away (just ask President H.W. Bush) which worried policymakers that weaknesses emanating from a credit collapse might still produce significant deflationary forces even after the 1990-91 recession had passed. It wasn’t until September 1992, a year and a half after it had officially ended, that Greenspan’s Fed finally finished their rate cuts.

All that happened, remember, without any public announcements. In those days, if you wanted to know what the central bank was up to you waited for banks in NYC to dissect Open Market trades in reserve markets like federal funds.

Looking forward in early 1994, however, things were different. This would be the first time the new target regime was lifted and a good number of Committee members (and staff) were concerned about doing it in the same way as before.

From the February 1994 FOMC meeting transcript:

CHAIRMAN GREENSPAN. This really gets to the issue that when we move in this particular context, which of course will be the first time we have moved since September 1992, we are going to have to make our action very visible. It’s more the equivalent of a discount rate move than the incremental federal funds rate changes that we have been embarking on for quite a long period of time. I am particularly concerned that if we choose to move tomorrow, we make certain that there is no ambiguity about our move. My understanding of the technical conditions in the funds market is that it looks as though the funds rate will probably be edging above 3 percent, and in the circumstances a draining action will be unambiguous to the professionals. But I’m not sure that more widespread recognition will come out very quickly; it will sort of dribble out. Under ordinary circumstances, that is not only fine but desirable. One of the things that we have argued, and I would continue to argue, is that there is a distinction between a discount rate and a federal funds rate action in the sense that we don’t want an announcement effect ordinarily on the funds rate. It gives us a much more calibrated instrument.

In other words, laypeople expected monetary policy was being set by the Discount Rate, which the Fed no longer did. Therefore, if they moved the federal funds target, which wasn’t a public target, the wider world might not get the signaled change in monetary policy stance (“a draining action will be unambiguous to the professionals” but who else beyond them?) It used to be that if you wished to tighten, you actually tightened, you know, that thing called money. Can’t fathom why the next few decades are filled with conundrums, here you go.

That was a hugely important piece of all this policy evolution. Once the Federal Reserve removed money from monetary policy, by choosing monetary ignorance, the whole thing really ran on expectations management. You can’t do that if you shift policy and nobody knows it. Greenspan colorfully associated it with banging.

CHAIRMAN GREENSPAN. But the point here is that when we move the discount rate, we’re hitting a “gong.” What I’m saying is that the first time we move the funds rate after this extended period, we are hitting a “gong.”

These transcripts (which Greenspan also fought against, until he realized they were needed in what he was trying to do, fool the world) are not edited, so it isn’t likely that any dissent along the lines of, “hey, this is all nonsense, we are a central bank for cryin’ out loud” was removed to create the appearance of unanimity. They all really thought this was good stuff.

So, on February 4, 1994, the FOMC issued its first “statement” accompanying a policy decision. It was short and appears to our second decade of the 21st century eyes improperly vague. From the world of 2018, it’s a pretty good metaphor for where we are and how we got here.

One final note. Why did they pick February 1994?

MS.PHILLIPS. Many of those were mentioned around the table with respect to labor shortages and supply shortages in areas where demand is particularly strong. We may well start to see commodity price increases working their way into the PPI and CPI. I think that we’re now seeing some major risks on the inflation front.

Some things never do change. Put that in your statements.

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