What Does The Fed Mean?

The progression from Alan Greenspan to Kevin Warsh is not simply a change in personality. It reflects four different views of how much the Federal Reserve should shape market expectations.

At one end is the belief that ambiguity preserves flexibility. At the other is the belief that communication itself is a monetary-policy instrument. Warsh appears to be pulling the institution back toward flexibility, but in a market that has become accustomed to continuous guidance.

Warsh seems to be drawing a distinction between transparency and prediction.

The Fed should explain why it made today’s decision. But that does not mean it should promise what it will do three or six months from now.

There is also a concern that excessive guidance encourages too much risk taking.

When investors believe the Fed has clearly mapped out the future, they may borrow short, lend long, buy duration, or sell volatility with too much confidence.

A less predictable Fed may force investors to price risk more carefully.

That may be healthier over the long term.

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