Fed Struggles To Steer Clear of Misinterpretation
By John M. Berry
Washington Post Staff Writer
Friday, May 2, 2003; Page E01
washingtonpost.com
When Federal Reserve policymakers meet next Tuesday, the last thing they will do before going to lunch is to agree upon a short statement explaining two decisions they will have made that morning -- each with a potentially significant impact on financial markets.
The first will be any change the central bank's top policymaking group, the Federal Open Market Committee, made in its very low 1.25 percent target for overnight interest rates. Most analysts expect none, though economic growth remains well below what Fed Chairman Alan Greenspan and other officials would like to see.
The second is the "balance of risks" statement. That is the participants' collective assessment of whether the pace of growth is more likely to lead to heightened inflationary pressures or to economic weakness, or are balanced between the two.
In the world of Fed watchers, where the phrases of Greenspan and other Fed officials are parsed for any sign of an action that can move markets, this second statement has become increasingly contentious among the policymakers and the analysts.
Numerous analysts have expressed unhappiness over the statement's formulaic approach. But such a check-the-box sort of statement is seen at the Fed as the only way to provide the public with information about the thinking of 19 participants without getting tied in knots trying to thrash out more nuanced wording that would be accepted by everyone.
Fed officials complain that the statement is often misinterpreted; analysts sometimes gripe that the statement is confusing.
Yesterday, for instance, economist Donald H. Straszheim of Straszheim Global Advisers in Santa Monica, Calif., told his clients he wishes the Fed would "kill the . . . practice."
Fed officials initiated the balance-of-risks assessments in early 2000 to replace their previous approach, which included language in post-policymaking-meeting statements on whether it was more likely that its next policy move would be a rate cut, a rate increase or that they were equally likely.
Committee participants, usually the seven members of the Fed board and the presidents of the 12 regional Fed banks, had come to feel that this "bias statement" was seen in financial markets as more of a commitment regarding the future course of rates than they really intended. Often, market participants treated the adoption of a bias in one direction or the other as virtually the same as a change in the target for overnight interest rates -- and a wide range of other rates began to adjust accordingly.
"We did not want to mislead markets," J. Alfred Broaddus Jr., president of the Richmond Federal Reserve Bank, said in an interview. "Our concern has always been that [the bias statement] would be seen as a commitment."
Now, the new balance-of-risks statement is less likely to be regarded as a commitment, Broaddus said, though some market participants still treat it that way.
Unhappiness with the balance-of-risk statement exploded among analysts after the committee met in March on the eve of the war in Iraq and provided no risk assessment at all. At a House Financial Services Committee hearing on Wednesday, Greenspan explained that "the risks and uncertainties surrounding the economic outlook" were so intense at that point that "we had little ability to distinguish temporary changes from more persistent shifts in underlying economic trends." And so the committee refrained making its usual determination, he said.
One area of confusion has been over the time period the balance-of-risk statement covers.
When the new approach was put in place more than three years ago, its announcement said the phrase "the foreseeable future" was "intended to convey a length of time extending beyond the next FOMC meeting," adding: "This concept is necessarily elastic, given that the relevant horizon may depend on economic conditions."
In recent months some analysts have scoffed at statements in which the committee said it regarded the risks as balanced, at a time when the economic recovery seemed to be faltering and inflationary pressures appeared to be minimal.
But Fed officials point out that the statement is intended to apply to a period as much as a year ahead -- not just the next month or two, and that the economy could look much different by then.
On the other hand, last November, when the Fed last cut rates, the adoption of a neutral balance-of-risks statement was intended to signal that the move was not the first in a string of cuts, Fed officials said later.
To Broaddus, the time period to which the balance-of-risks statement applies is nine months to more than a year, the period over which the policy decision just made would be likely to affect economic growth and inflation.
"I am currently thinking through the end of 2003 and into 2004," he said. "That is the period in which what we are doing may be transmitted to the economy.
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