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Pastimes : The Hot Button Questions:- Money, Banks, & the Economy -- Ignore unavailable to you. Want to Upgrade?

To: maceng2 who wrote (763)	5/4/2005 1:34:30 AM
From: maceng2	Read Replies (1) \| Respond to of 1417

The Fed's Failure to Communicate businessweek.com Policy statements once meant something. Now they peddle platitudes -- and with a new chairman on the way, that's especially dangerous The Federal Reserve had conspiracy theorists chattering on May 3 when it said it inadvertently left a sentence about inflation expectations remaining "well contained" out of the monetary policy statement it had issued earlier in the afternoon. To hear the wags in the financial markets tell it, the revision showed that the Fed had experienced trouble crafting that part of the statement and was deeply divided over the inflation risks facing the economy. Baloney! The truth is more mundane: It was a case of a simple transcribing error, nothing more. Unfortunately, though, for the Fed, the innocent omission is a metaphor for something far more serious. The central bank's communication channel with the financial markets is breaking down. The statement that it issues after every meeting, especially the portion intended as a guide to future interest rate actions, has become increasingly meaningless. "The statement is broken," says economist Louis Crandall of consultants Wrightson ICAP. "They've got to scrap it and get a new model." How the Fed communicates with the markets is critical. After all, Chairman Alan Greenspan and his central bank colleagues control only one crucial interest rate -- the federal funds rate -- the rate that commercial banks charge each other for overnight money. Other economically more important rates, such as the yield on Treasury securities or the rate on home mortgage loans, are set by the markets. The Fed can influence the markets by what it does with the funds rate and what it says about the economy. But it can't control them. EMPTY WORDS. Judging by the market action May 3, the central bank's policymaking Federal Open Market Committee (FOMC) is having trouble getting its message across. Stock prices changed direction no less than eight times after the Fed statement -- before ending the day little changed as investors struggled to parse the meaning of the central bank's words. It's little wonder that investors are having difficulties divining the Fed's intentions, given how muddled the statement has become. Yes, Greenspan & Co. repeated on May 4 that it's likely to continue to raise the fed funds rate at a "measured" pace. But despite what some in the markets might think, that's no guarantee the Fed will raise rates another quarter of a percentage point at its next policymaking meeting on June 29-30. According to the minutes of the Fed's March meeting, the "measured" language doesn't rule out the central bank either taking a break from raising rates or stepping up the pace of its increases. In other words, measured is all but meaningless. FUELING INFLATION. So, too, is the portion of the Fed's statement devoted to assessing risks to the economy. The central bank repeated on May 3 that it believed the risks to sustainable economic growth and price stability would be kept roughly equal, provided it followed "appropriate" monetary policy. Duh. That's what Fed policymakers are paid to do. "The balance-of-risks assessment has been neutered," Paul McCulley, managing director at the giant bond-fund manager Pacific Investment Management wrote in a recent report. "Rather than being a guidepost for we, the markets, to assess whether the FOMC needs to adjust policy, it has now become a platitude for the FOMC's commitment to act appropriately." The Fed's message to the markets may be becoming more unclear because the central bank itself is less certain than before of both the economic outlook and what it should do in response. The run-up in oil prices is slowing economic growth as motorists are forced to pay more to fill their gas tanks and thus have less money to spend at the malls. But higher energy prices are also pushing up inflation throughout the economy -- a point the Fed tacitly recognized on May 4 -- as companies pass on increased oil costs to their customers. TOUGH CHOICES. The hit to growth and inflation from higher energy prices presents Greenspan & Co. with a dilemma. "The Fed can't fight slowing growth and rising inflation at the same time," says Princeton University Professor Alan S. Blinder, a former vice-chairman of the central bank. "It's a choice of where do you want to take your lumps." Still, it remains worrisome that the Fed and the markets look to be having trouble understanding each other. And it's a particular concern given that Greenspan is in the closing days of his career. After 18 years atop the central bank, financial markets have become very comfortable with how Greenspan operates. So have the chairman's fellow members on the FOMC. A new Fed chief -- no matter who the policymaker is -- won't enjoy such deep trust. That's why the Fed needs to map out a new communication strategy soon to help in its efforts to manage the markets and the economy.