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Mixed messages

March 24, 2014 - 12:05am

A central banker needs many attributes: economic expertise, knowledge of financial markets, plain old good judgment. During his innovative tenure as chairman of the Federal Reserve, Ben S. Bernanke proposed another quality for the list: great communicator. Mr. Bernanke felt that, when the Fed had exhausted conventional tools by driving interest rates to zero, it needed to shape market expectations through open expressions of its intentions. As part of that push for transparency, Mr. Bernanke held news conferences following its regular policy-setting meetings.

Mr. Bernanke’s successor, Janet Yellen, met with reporters Wednesday and, bluntly, it didn’t go all that smoothly. Responding to a question, Ms. Yellen hinted that the Fed might start raising interest rates above zero “around six months” after phasing out the current bond-buying stimulus program; bond markets quickly sold off, which was almost certainly not what Ms. Yellen intended. Ms. Yellen also assured investors that there was no great significance to the Fed’s decision, announced Wednesday, to back off its previous plan to raise rates after unemployment hit 6.5 percent. But markets looked past her words to other Fed officials’ own interest-rate forecasts and drew contrary conclusions.

Part of the problem was that, in hindsight, the 6.5 percent unemployment target was ill-advised: The economy is approaching that rate, but other indicators show that the labor market is still too weak to justify raising interest rates. Abandoning the benchmark, as Ms. Yellen did Wednesday, was therefore probably both inevitable and advisable. But she couldn’t really point to anything very specific to take its place. Instead, the Fed’s statement alluded to “a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments.” In an effort to provide more actionable information, Ms. Yellen ended up providing less. And traders gambled accordingly.

This is not a comment on Ms. Yellen’s capabilities, which are considerable, or her good faith, which is axiomatic. Mr. Bernanke himself caused an unintended but costly market kerfuffle last year when investors — incorrectly, as it turned out — interpreted one of his speeches as a promise to reduce bond-buying by a certain date. The point, rather, is that there are limits to how much any Fed chair can fine-tune the economy with his or her words, even carefully chosen ones. Sometimes markets just hear what they want to hear.

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