Speaking Too Clearly

Fed chairman's efforts to clarify throw off markets

By Kevin G. Hall
Knight Ridder Newspapers
Posted on Thu, Jun. 08, 2006

The new chairman's rough patch began on April 27, when he signaled before the Joint Economic Committee of Congress that after 16 consecutive interest-rate increases since June 2004, a pause might be in order. Stocks rallied.

Days later, however, in what he thought was a private conversation with a CNBC reporter, Bernanke said that the markets had misunderstood his message and that a pause was in no way certain. CNBC reported it on May 1, sparking a Wall Street roller-coaster ride.

Soon after, data came out suggesting that energy prices were driving inflation to the upper limits of the Fed's comfort zone. The implication: A late June rate increase was now more likely than a pause.

Bernanke's words in April had proved too optimistic, given that the Fed's main mission is to quell inflation, primarily by setting short-term interest rates.

Testifying before the Senate in late May, Bernanke apologized for "a lapse in judgment on my part" in talking loosely to a reporter. In the future, Bernanke said, he'd stick to formal channels to communicate to the public.

But even speaking that way roiled the markets. In a speech to a Washington conference on Monday, Bernanke left little doubt that future rate increases should be expected because price inflation had reached a danger zone.

The Fed chief also said that the U.S. economy is showing signs of slowing down. He pointed to slowing consumer spending, the cooling housing market and slower job growth. A slowing economy normally prompts an end to rate increases or spurs rate cuts to rekindle economic embers. But Bernanke left no doubt that he's more worried about rising inflation than slowing growth - and their combination is troubling.

"These are unwelcome developments," he said.

The Dow Jones industrials promptly plunged 200 points, and stocks slumped further through the week. What the markets heard was that rate hikes might extend beyond the next expected bump up to 5.25 percent at the Fed's June 28-29 meeting.

Why such volatility? Bernanke, after all, was just engaging in the "plain speak" he'd promised.

Blame Greenspan, who for more than 18 years as Fed chairman developed an oft-impenetrable language to communicate the Fed's thinking.

"I guess I should warn you, if I turn out to be particularly clear, you've probably misunderstood what I've said," Greenspan once famously quipped.

The markets, it appears, don't want straight talk.

"The markets and Bernanke haven't quite learned how to listen to each other," said James Glassman, a senior economist for investment bank JP Morgan Chase. "I'm sure he thinks he's leaving the door open ... but the market needs simple messages, and the markets have sort of been used to getting spoon-fed."

The danger in Bernanke's plain talk is that it creates expectations that can be dashed by new contradictory data. When he said that future Fed rate decisions would be dependent on emerging data but looked favorable for a pause, he didn't leave the Fed much wiggle room for unexpected data - as the next set of inflation numbers promptly proved.

Greenspan avoided trapping himself in pronunciations that upset the markets, preferring carefully worded vague statements that led market analysts to debate endlessly what he meant. That left him room to act as he saw fit.

Bernanke's signals, on the contrary, set off market forces that now complicate his future rate decisions.

Two prominent former Federal Reserve governors interviewed by Knight Ridder suggested that Bernanke's problems are less self-inflicted than a reflection of how difficult it is to determine when to stop raising interest rates.

"The problem here is that Bernanke came in when the easy work was over. Bernanke was not able to give the kind of more precise guidance" that comes earlier in a rate-raising cycle, said Laurence Meyer, a Fed governor from 1996 to 2002.

Conducting monetary policy is like navigating in fog.