Let’s get this straight: Warsh hates forward guidance.
The Federal Reserve chair nominee has repeated several times this message, like in the Senate Banking Committee hearing last month: “I don’t believe in forward guidance. I don’t believe that I should be previewing for you what a future decision might be. I think it’s essential that the Fed make decisions in the room.”
Forward guidance is one of the obvious targets of Warsh’s regime change to the US central bank. As Powell recently said, the Fed chair has the power to review the communication strategy, and every chair did that.
The FOMC Dissents Were About Forward Guidance
But if we look at the three dissent statements from the Reserve Bank Presidents who voted against the FOMC decision, we can see that forward guidance is not a thing that Fed officials will easily concede.
Neel Kashkari, Lorie Logan and Beth Hammack dissented in the last FOMC meeting not because of the decision to hold the rate unchanged, but due to the “easing bias” language that remained in the post-meeting statement.
The so-called “easing bias,” as they explained in their dissent explanations released on Friday, persists because the word “additional” remains in the sentence “In considering the extent and timing of additional adjustments to the target range for the federal funds rate…”
Say Less Is Also a Form of Forward Guidance
As Hammack explained: “This forward guidance was put into the statement to signal a pause rather than an end to the easing cycle.”
Kashkari concurred: “While that phrase is not a commitment to make further cuts to the policy rate, it is widely interpreted by Fed watchers to indicate the Committee’s expectation that the next adjustment to the federal funds rate would be a cut. I consider this language a form of forward guidance about the likely direction for monetary policy.”
Logan further illustrates their point: “When the FOMC gives forward guidance about the likely course of future interest rates, as in the recent post-meeting statement, that guidance is an important policy tool.”
The framing across all three explanations is consistent. On top of their common rejection of the language, all of them cited “forward guidance” as the reason they thought this issue was dissent-worthy.
Notably, during the press conference, Powell also brought up “forward guidance” when addressing this “easing bias” situation. When explaining why the “majority” of the FOMC preferred not to change the language, Powell explained: “These changes, it’s a form of forward guidance… you want to make them in a way that will be sustained and continue to make sense and not something you need to take back fairly quickly.”
The three dissent voters were saying that not changing the statement’s wording is a form of forward guidance; Powell said that, dropping the easing bias is also a form of forward guidance and they don’t want to do it lightly.
So, no matter what they choose to do, the decision itself is a form of forward guidance. This raises the question of how Warsh can ditch forward guidance and keep the decision in the meeting room.
Of course, Warsh’s “rejection” of forward guidance can be understood in a much more narrow sense—he is against the Fed using Summary of Economic Projections, commonly known as the dot plot, as a major communication tool; he is also against Fed officials, especially Reserve Bank presidents, making too many public speeches or media interviews.
These are subjects that are worthy of serious review, of course. As Powell himself said, “I was never the world’s biggest fan of the dot plot, but you can’t beat something with nothing.”
Nonetheless, Warsh’s messaging has been decrying forward guidance as a whole. This is untenable. As the Regional Fed presidents showed with their dissent, anything that can help the market speculate where the future interest rate will go, it is a form of forward guidance. An unchanged statement is forward guidance; one less word mentioned is also forward guidance.
Forward Guidance Is Not Merely a QE By-Product
Forward guidance is also not a by-product of quantitative easing; not necessarily. Economists recognize that the Fed adopted forward guidance since the early 2000s when the meeting statement started to include lines like “the Committee believes that policy accommodation can be maintained for a considerable period.”
In such a formulation, the central bank is communicating their expected reaction function to the market. “If A happens as we expected, then the Fed will move the interest rate this way.”
In recent years, such communications evolved further into the so-called central bank scenario analysis: the central bank tells you not only what they think they will do when A happens, but also their options when B, C or D happens.
Now, is this over-communications? Could be. For example, I found the Bank of England’s current scenario analysis method too long-winded and made my head spin. But does it make me want to cancel forward guidance? No, I just want the communication to be clearer and straightforward.
The Paradox of Cancelling Central Bank Communication
The paradox of cancelling central bank communications is that you will have to do a lot of communications about it. “Keeping the decision in the room,” doesn’t actually explain what you want to do. Saying less or saying nothing are also communications.
Let’s take the current economy as an example. The April Jobs report showed another month of strong payroll growth, pushing interest rate markets to price in an even higher chance of a hike.
But we also know one of the major factors President Trump used to pick Warsh is how likely he will push for rate cuts. So, there is a conflict. Communications can help smooth this potential conflict. Imagine Warsh magically pushed successfully for a rate cut while the market expects a hold, that could create unwanted volatility in the market. Is this what Warsh prefers?
In an interview with Financial Times’ Soumaya Keynes, Chicago Reserve Bank President Austan Goolsbee was asked about his view on Warsh’s reservations on communications, he said he shared some of Warsh’s skepticism.
“I have been a little skeptical of forward guidance in an environment that is not at the zero lower bound… I just think [the interest rate tool] is not binding, what’s the point… Who are we to try to put some binding constraints on future committees?”
This is the style of communications about central bank communications I would like to hear more of—explanation-based rather than gesturing and throwing politically pleasing buzz words around. When Warsh assumes the Fed chair position, he needs to seriously handle this paradox of communications.
