The U.S. Federal Reserve's ability to control inflation has been bolstered by its credibility in financial markets, but this trust had to be earned through concrete actions, according to new research presented at the Kansas City Fed's annual conference in Jackson Hole, Wyoming. While market confidence in the Fed’s commitment to its 2% inflation target under Chair Jerome Powell eventually solidified, it was not solely due to verbal assurances. The research emphasized that this belief only took hold after the Fed began raising interest rates in March 2022 and subsequently accelerated the hikes.
Economists Michael Bauer from the San Francisco Fed, Carolin Pflueger from the University of Chicago, and Adi Sunderam from the Harvard Business School found that substantial rate hikes were necessary for shifting market perceptions. "Forecasters and markets were highly uncertain about the monetary policy rule prior to 'liftoff' and learned about it from the Fed's rate hikes," the researchers noted, underscoring that public understanding of the Fed's strategy was unclear until tangible actions were taken.
The study serves as a caution to central bankers about over-relying on "talk therapy," the notion that economic outcomes can be influenced through words and promises alone. Despite numerous speeches and public comments by Fed officials aimed at fostering transparency, it was ultimately the decisive policy actions that convinced markets of the Fed's determination to control inflation.
U.S. stocks surged on Friday following comments from Fed Chair Jerome Powell, hinting that interest rate cuts might be forthcoming. However, the research highlights that the Fed's credibility, and thus its effectiveness, was not guaranteed by words alone. Survey data showed that even as inflation began rising in 2021, professional forecasters were uncertain about how the Fed would react, with expectations of a Fed response to inflation near zero.
It wasn’t until after the first rate hike in March 2022 that perceptions began to shift. The shift became more pronounced with the Fed's move to a 75-basis-point hike in June 2022 and Powell’s assertive speech at the Jackson Hole conference that year, reaffirming his commitment to the inflation target despite potential economic pain.
As market perceptions of the Fed’s sensitivity to inflation grew, the effectiveness of monetary policy improved. The research concluded that for future policymakers, actions are crucial for establishing credibility. "Policy rate actions contribute to, and may even be necessary for, the effectiveness of communication," the researchers stated, suggesting that the Fed could enhance transparency by making its "reaction function" more explicit in its quarterly economic projections.
In sum, while transparency and communication are important, this research underscores that in times of uncertainty, decisive policy actions are key to reinforcing the Fed's commitment to its goals.
(Source:www.reuters.com)
Economists Michael Bauer from the San Francisco Fed, Carolin Pflueger from the University of Chicago, and Adi Sunderam from the Harvard Business School found that substantial rate hikes were necessary for shifting market perceptions. "Forecasters and markets were highly uncertain about the monetary policy rule prior to 'liftoff' and learned about it from the Fed's rate hikes," the researchers noted, underscoring that public understanding of the Fed's strategy was unclear until tangible actions were taken.
The study serves as a caution to central bankers about over-relying on "talk therapy," the notion that economic outcomes can be influenced through words and promises alone. Despite numerous speeches and public comments by Fed officials aimed at fostering transparency, it was ultimately the decisive policy actions that convinced markets of the Fed's determination to control inflation.
U.S. stocks surged on Friday following comments from Fed Chair Jerome Powell, hinting that interest rate cuts might be forthcoming. However, the research highlights that the Fed's credibility, and thus its effectiveness, was not guaranteed by words alone. Survey data showed that even as inflation began rising in 2021, professional forecasters were uncertain about how the Fed would react, with expectations of a Fed response to inflation near zero.
It wasn’t until after the first rate hike in March 2022 that perceptions began to shift. The shift became more pronounced with the Fed's move to a 75-basis-point hike in June 2022 and Powell’s assertive speech at the Jackson Hole conference that year, reaffirming his commitment to the inflation target despite potential economic pain.
As market perceptions of the Fed’s sensitivity to inflation grew, the effectiveness of monetary policy improved. The research concluded that for future policymakers, actions are crucial for establishing credibility. "Policy rate actions contribute to, and may even be necessary for, the effectiveness of communication," the researchers stated, suggesting that the Fed could enhance transparency by making its "reaction function" more explicit in its quarterly economic projections.
In sum, while transparency and communication are important, this research underscores that in times of uncertainty, decisive policy actions are key to reinforcing the Fed's commitment to its goals.
(Source:www.reuters.com)
