Federal Reserve’s Fischer Discusses Central Bank Communication

Stanley Fischer, vice chairman of the Federal Reserve System, visited SIPA on April 17 to give the inaugural Lecture on Central Banking.

Speaking about central bank communication, Fischer said that actions by the Fed can surprise because central banks are obligated to follow an appropriate monetary policy regardless of market expectations.

But “not all surprises are equal,” Fischer observed.

Some can be more disruptive than others, he said, noting that “there are good reasons to avoid unintended surprises in the conduct of policy.”

Fischer explained that “repeated market surprises . . . could threaten to disrupt the relationship between the central bank and the markets, making the central bank's job more difficult in the future.”

But avoiding surprises isn’t always easy, Fischer said. To illustrate why, he recounted the story of the “taper tantrum” of 2013, and why markets reacted so strongly to a move that was considered unsurprising to the median observer.

Fischer explained that the Fed may have relied too heavily on surveys of market participants who were already close Fed-watchers. This narrow survey data was not representative of wider expectations.

Citing an argument by economist Jeremy Stein, Fischer emphasized that the “market” is diverse and can often hold “widely divergent but perhaps strongly held beliefs at the individual level,” and that the reaction of these participants fueled the taper tantrum.

The Fed has learned from this, said Fischer, and has improved its information-gathering methods and survey questions to more accurately measure both the dispersion of beliefs as well as how firmly held those beliefs are. He also emphasized that clear communication by the Fed is essential to manage the market’s expectations and avoid surprises.

However, quoting Stein again, Fischer stressed, “There are very real limits to what even the most careful and deliberate communications strategy can do to temper market volatility. This is just the nature of the beast when dealing with speculative markets, and to suggest otherwise--to suggest that, say, 'good communication' alone can engineer a completely smooth exit from a period of extraordinary policy accommodation--is to create an unrealistic expectation."

Assessing the Fed’s renewed efforts to improve its information-gathering and communications strategies, Fischer commented: “My tentative conclusion from market responses to [reducing the size of our balance sheet] is that we appear less likely to face major market disturbances now than we did in the case of the taper tantrum.”

In closing, Fischer noted that the Fed—in its pursuit of unsurprising policies—can also risk becoming too predictable. If the Fed is too path-oriented and does not incorporate enough uncertainty about the economy into its projections, then its policies will not adequately respond to unexpected market shocks.

— Matt Terry MIA ’17

Photo by Barbara Alper