By Howard Schneider
July 6 (Reuters) – Forward guidance can be a “valuable tool” that speeds the impact of monetary policy under the right circumstances, though it can be a problem when used inflexibly, Federal Reserve Governor Christopher Waller said on Monday in remarks highlighting debate within the central bank about how monetary policy should be discussed.
“I continue to believe that forward guidance can be a valuable tool that has, at times, significantly strengthened policymaking and will continue to be useful,” Waller said in remarks to a Bank of Italy conference in Rome on monetary policy transmission.
Despite estimates that interest rate changes may take one to two years to influence the economy, Waller, who unlike Fed Chair Kevin Warsh holds a doctorate in economics and leans heavily on research findings in shaping his policy views, noted that when the Fed in the fall of 2021 started steering investors towards coming rate hikes, market interest rates began to rise steadily.
“When it works, forward guidance can change economic conditions more quickly than adjusting the policy rate alone,” Waller said.
His remarks contrast with the tone set by Warsh, who has emphasized that forward guidance can make a central bank less nimble in responding to new economic developments and has discouraged its use — at least in the current environment. The statement issued after Warsh’s first meeting as chair removed references to what sort of rate adjustments the Fed might make.
Fed communications — what information gets relayed to the public about its deliberations — will be a focus of one of five task forces Warsh plans to name as soon as this week to make recommendations about different aspects of U.S. monetary policymaking.
Forward guidance is one part of that, but the review is expected to be much broader and encompass issues like whether the Fed should continue to issue interest rate projections every quarter, or whether the chair should continue holding press conferences after every meeting.
Warsh has styled himself after the late former Fed Chairman Alan Greenspan in arguing that sometimes saying less leads to better decisions, a factor in the changes made to the Fed’s policy statement at his first meeting.
Further clues to his approach could come on Wednesday with the release of the minutes of that initial meeting, with some analysts expecting changes to the format and others saying the document could carry more impact than usual given the absence of guidance in the policy statement and from the chairman.
“Much shorter minutes would not be a surprise,” Derek Tang, a Fed analyst with LH Meyer, wrote on Monday.
As a product of the Federal Open Market Committee, Warsh would need the support of his colleagues to dramatically reformat or change the minutes. Released three weeks after each Fed meeting, the document provides an account of staff views about the economy, as well as information about the different policy arguments presented with some indication of how many officials supported a particular view — from “one” to “most” to “all,” with several steps in between.
It can often augment or reshape how the policy statement of a given meeting or the comments made at the chair’s press conference are construed by investors, the media, and the public.
Waller’s comments in Rome showed how the debate over communications is already taking root.
In an appearance in Portugal last week, Warsh skirted even questions about the economic outlook — a staple of Fed commentary that he told a questioner was little better than parlor sport that would amount to the sort of forward guidance he has pledged to avoid.
Waller said the Fed can only hide its cards so much, and needed to make sure investors understand how officials would react to different economic developments.
“As long as your reaction function is well defined and well understood you don’t have to necessarily talk that much,” Waller said. “But if your reaction function is not well defined — you need to speak,” a point some market analysts have made in the wake of Warsh’s first press conference.
Waller did agree with the new chair that there are moments when providing guidance about future policy “has hindered, rather than helped.”
The fall of 2021 was an example of that as well, he said, when the Fed talked about raising rates, but felt so bound by prior guidance that it did not approve a rate hike until March 2022.
While not providing his views about the current situation, Waller also noted that forward guidance can cause trouble at moments when several different economic outcomes or scenarios seem equally likely.
Fed officials right now are torn over whether inflation or risks to employment are the bigger concern.
“If it is not flexible enough, it can hinder policy transmission. And, in some cases, it’s best not to use it at all,” Waller said.
(Reporting by Howard Schneider; Editing by Andrea Ricci)
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