Betsey Stephenson and Justin Wolfers take us on a journey to Hundred Acre Wood:
Eeyore and Tigger have become central bankers. The wood's economy is suffering the repercussions of a recent honey binge. Both Eeyore and Tigger want to help the recovery along, a goal they hope to achieve by holding interest rates low for a long time. But each communicates this differently.
Chairman Eeyore is a true dismal scientist, who sees bad news everywhere. He's sure the economy will be in the doldrums for years. Indeed, he's so worried that folks who don't understand his pessimistic outlook will make bad decisions that he gives a speech warning them about it. He says the economy is so weak that he'll need to keep rates low for several years. Eeyore's message is so sobering that it mutes the desired stimulus effect of the low interest rates. After all, why would you buy anything, or invest in producing it, if you have just learned that some of the smartest forecasters in the country think the economic outlook is so awful that they dare not raise rates until 2014?
Chairman Tigger has a totally different approach. He figures that the prospect of a terrific party will revive everyone's animal spirits. He also knows what folks are thinking: Every time the economy gets going, the Fed spoils the party by taking away the punch bowl -- that is, by raising interest rates to keep inflation in check. So Tigger gives a speech promising to keep interest rates low for several years -- even when the economy recovers.The prospect of low interest rates sustaining a long and robust recovery leads everyone to start spending. After all, good times are just around the corner.
Eeyore and Tigger both did essentially the same thing. They announced that interest rates would be low for several years. But their messages are importantly different, and so yield very different effects.
Their point is that Ben Bernanke has been acting too much like Chairman Eeyore. I agree, but would add that it is nearly impossible for Bernanke to act differently given the format of the new long-term interest rate forecasts. The format shows where FOMC officials expect the federal funds rate to be over the next few years. What is missing and essential for knowing the stance of monetary policy is the expected natural (or equilibrium) federal funds rate. A federal funds rate is only stimulative if it is below its natural rate level. It is not enough for the federal funds rate to be low, for the natural interest rate could be low too.
If the FOMC would show the forecasts of the actual and the natural federal funds rates over the various forecast horizons, then the public could know with much more clarity the Fed's intentions. Until then, the Fed's new communication strategy is at at best white noise to the market and at worst worst a quagmire of confusion.