Kevin Warsh is underselling the value of chatter

Kevin Warsh is starting to win converts to his side. Warsh, the newly installed Federal Reserve chair, has made one of his early priorities cutting down on the amount of chatter that comes out of the Fed. In that sense, you could argue he's trying to take the Fed back to its roots, back before Alan Greenspan and the modern, talkative central bank. 

Speaking to bankers in Italy, Fed Gov. Christopher Waller said he was on board with the pivot, our Kyle Campbell reported. Sometimes, Waller said, "forward guidance," as it is rather awkwardly called, can be a valuable tool for the central bank. Sometimes it does more harm than good. He pointed to September 2020, when the Fed's guidance was to let inflation "moderately exceed 2% for some time." Those last three words, he said, became a problem. They were too vague.

"Forward guidance is more art than science," Waller said. 

He's not wrong about that, because every time a Fed official talks, whether they consciously mean to or not, they are setting expectations among investors and the public. In the wake of the 2008 crisis, the Fed flooded the economy with liquidity, buying trillions worth of bonds, and cut rates to zero, refloating the entire economy. While some people – including the current Federal Reserve chair – warned this would create inflation, it didn't. Why? Well, I'd argue it was because the Fed, mainly in the person of Ben Bernanke, used the "art" of talking to set expectations. Bernanke drew a proverbial line in the sand and said the Fed would ensure inflation was at 2%. That was all he really had to do. He just spoke it into existence, repeated it time after time after time, and the market came to expect it. 

Waller's pandemic-era example goes in the other direction, though I'd argue he is missing the main point. The problem wasn't the "for some time" language; the problem was the Fed saying at all that it would let inflation rise. To my knowledge, no central banker had ever publicly said such a thing. Of course inflation rose! The central bank told people inflation was going to rise. Everybody expected inflation to rise, and tried to get in front of it. The statement created the reality. 

That episode perfectly illustrates the power of the Fed's ability to move markets through nothing but jawboning. I wonder if Warsh or his compatriots fully understand the degree to which their public statements are an incredibly powerful tool, possibly even as powerful as any of the monetary machinations under their control. With just some words, they can essentially set the entire global market in one direction or the other. Maybe Warsh does fully understand that, and think it's too dangerous a power to wield.

I wouldn't be surprised if Warsh eventually reverses course on this. The ability to bend markets to your will comes only with repetition, and it's a very handy tool for the Fed to have in a crisis, as Bernanke illustrated. Maybe it's something that can just be turned on or off when needed. But think about who you trust in a crisis, when things are really dire. Is it the person you know, or the one you don't?