Bernanke's road to transparency is paved with good intentions

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Wen Nan Tan's picture

Now that Janet Yellen has finally been named the next chairman of the Federal Reserve, it is natural to consider the legacy of her predecessor.

Ben Bernanke, so-called ‘helicopter Ben’, the man who hovered above us all, his academic rotors working overtime, architect behind the programme of quantitative easing, showering us with billions of dollars of liquidity.

Unfortunately, his legacy is nowhere near as untainted as many commentators seem to think. Let’s not beat about the bush. Helicopter Ben has come crashing down to earth.

Consider these two statements.

The first from former Fed governor Alan Greenspan, “Since I’ve become a central banker, I’ve learned to mumble with great incoherence. If I seem unduly clear to you, you must have misunderstood what I said.”

And here comes Helicopter Ben himself. “As public servants whose decisions affect the lives of every citizen, central bankers have a responsibility to provide the public as much explanation of those decisions as possible….The more guidance a central bank can provide the public about how policy is likely to evolve, the greater the chance that market participants will make appropriate inferences.”

The approach that Alan Greenspan and Ben Bernanke each took could not be any more different. To Greenspan, obfuscation is key while Bernanke believed in the importance and necessity of transparency.

It is in this crucial area that Ben Bernanke’s legacy has been compromised. For a man who took it upon himself to steer the Fed into the clear seas, Bernanke has in fact muddied the waters. It is a great shame, as he started so well.

The financial crisis of 2008 crippled the world economy and left many high and dry in its wake. With the public clamouring for answers, regulatory boards scrambling to find a scapegoat and the media running sensationalist headlines on greedy bankers, one man stood bravely amidst the chaos and vowed to bring change.

Ben Bernanke pledged to remove the shroud of secrecy that had safely disguised financial institutions. Transparency became his byword. It was his defining characteristic. It would mark his legacy. He slammed the Fed’s opacity in its communication strategy as one of the causes of the Great Depression. During his term of chairmanship, he tirelessly campaigned for openness and clarity in the central banking system.

No one could have expected that this same man would now, ironically, wither under the spotlight of the recent QE3 controversy.

When the time drew near for a decision on QE3 to be made, Bernanke discussed the slowing of the stimulus programme and mentioned it would probably occur before the year’s end, once unemployment rate reached 7%.

After this statement was released in June, the Fed remained unusually quiet and did not send any signals that would suggest a change in course. Hence, when August unemployment rates were reportedly 7.3%, the definitive threshold initially mentioned appeared to have been met.

The combination of Bernanke’s words as well as general market sentiment that a recovery was underway created expectation that the Fed would start to gradually pull back on its quantitative easing, the so called taper. With no signs or reasons to believe any deviations would occur, market participants were fully convinced that QE3 would mark the start of tapering.

They were wrong.

The Fed’s decision to continue its asset buying programme essentially injected hot money into the markets. With credit constraints substantially relaxed as a result of this expansionary measure, positive sentiments about the near future translated itself to excitement that rallied the stock markets.

Investors reacted, pushing the S&P500 and Dow Jones Industrial Average to record highs. The value of gold glittered brighter than ever while the yield on 10-year Treasury notes fell. The party moved beyond American shores and continued in the Asia Pacific region. Market indices rose in Sydney and Tokyo as stock prices in Hong Kong, Singapore and Malaysia all experienced similar increases.

However this concept of optimism was clearly divergent as the very same notion painted a strikingly different picture on Wall Street with analysts and economists left dumbfounded and caught off guard.

Transparency in the central banking system has long been encouraged by academics. This principle is also endorsed by Bernanke himself and is made the hallmark of his reign as chairman of the Fed. Bernanke aimed to bring sufficient openness to the system such that investors were able to receive clear signals of the Fed’s plans.

However, in light of the QE3 controversy, Bernanke remained adamantly unapologetic and explicitly stated that it is the not Fed’s responsibility “to let market expectations dictate policy actions”.

Although there is truth in the statement, it is still within the Fed’s interest to effectively communicate clear forward guiding principles and correct or dispel any conflicting market expectations that were formed ahead of important announcements.

The decision to withhold tapering was at odds with market expectations. Not only did it demonstrate how far off expectations were from reality, it shined a spotlight on how out of sync the Fed and the markets were. It was undeniably clear that there had been some sort of communication breakdown between the Fed, the markets and market participants.

The Fed’s mandated macroeconomic goals would be easier to achieve if the public fully understands them and believes that the Fed will take effective measures to achieve them. Therefore, it is imperative that the Fed makes active efforts to succinctly and clearly communicate its objectives. These messages would then serve as forward guiding signals to aid the market in its navigation to complement the likely path of future monetary policy.

The significance of forward guidance should not be underestimated. It ensures that the market’s expectations on future monetary policy are in line with the Fed’s policy intentions. From the perspective of maintaining monetary stability, the provision of sound guidance reduces uncertainty in the markets that are undesirable. Otherwise, monetary policy actions may itself become a source of volatility as exemplified by the Fed’s unexpected decision to withhold tapering in QE3.

Inconsistency in messaging also complicates the economic decisions of the general market. Unclear communication strategy will result in market participants making key irreversible decisions that may have long lasting consequences. To avoid such situations, the Fed could adopt clear communication strategies to reassure market participants.

Bernanke’s efforts and courage in the overhaul of Greenspan’s 18 year tradition of arcane statements and mystifying central bank are indeed commendable. He has built for himself an image and reputation of trustworthiness after successfully championing the implementation of a clear communication strategy within the central banking system. So much so that when the world’s most powerful central banker speaks, market participants duly respond.

As far as he has come, however, this recent lapse has undoubtedly set him back a few steps. Although the ramifications of the misguided markets were not catastrophic this time around, how well a role Bernanke played as gatekeeper to the Fed has inevitably come into question.

Credibility can only be built over time, and is built from the history of one’s words and actions. Since the recent blemishes on his record are now ineradicable, Bernanke should look to the future and try restoring the dignity and integrity that has been stripped off his legacy by his swansong as Chairman of the Fed.