Precision in verbal engineering
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Buried in the latest minutes released by the Federal Open Markets Committee is a veiled warning that the tools to tackle the next financial crisis may be lacking
You are driving down a remote country road. It's a wild, wet and windy day and your poorly maintained car has a puncture. You realise it’s your own fault because you haven’t checked the tyres recently and you were driving too fast for the conditions.
You now that your ancient, rusty jack that has been used too many times in the past will buckle but you think that if you pump it up you will be able to limp to the next town and get a repair. As you give the foot pump the last push it breaks. "Phew!" you say to yourself, "that was lucky." You climb in the driver’s seat and resume your journey.
You've only gone a few yards when "Bang!" A wheel falls off. You've used your spare wheel; the jack is kaput, and the pump has blown it. And there is no mobile signal to call out the AA.
Central banks used to have a toolbox that a range of devices for keeping economies on track, moral suasion, forward-guidance, raising and lowering interest rates, fractional reserves and more recently quantitative easing. It was, of course, governments that maintained the economy and were supposed to provide regular safety checks (like the annual MOT test for cars in the UK) but governments responded to the needs of interest groups like bankers and consumers and rather neglected their jobs and even central bankers didn't want to spoil the party and kept the punch bowl charged to overflowing.
2008 saw a lot of head scratching. A financial crisis with the tools in the toolbox having been used to exhaustion over the years what to do? A new tool for the job: the name gave it away "extraordinary monetary measures" or quantitative easing. The measures worked in so far as there was no mass unemployment and economic collapse, but asset prices and emerging market debt soared which the central bankers hadn’t entirely predicted.
In the days leading up to the annual US Federal Reserve jamboree in Jackson Hole, the Fed released the most recent minutes of Federal Reserve's Open Market Committee (FOMC) meeting held on 31 July and 1 August this year.
Focus on their content was on their justification for raising interest rates but those with longer time horizons will note the other angle to their discussion.
In its arcane language the FOMC "expressed concern about the potential limits on policy effectiveness stemming from ELB." In other words, the committee didn't think rock-bottom interest rates or other tools in its armoury would always be effective in the event of weakening of labour markets or a rise in demand for secure assets.
The FOMC admitted that researchers were uncertain about the costs and the effectiveness of such tools as quantitative easing and not only expressed concern about shaping public expectations about the potential future use of such tools but some participants in the meeting, "…cautioned against being too specific about how the Committee would deploy such tools." Or indeed "what" tools.
To the outsider it is not unreasonable to draw the conclusion that the FOMC is in the position of the driver of a car that has a broken jack and a busted pump isn’t sure what tools it will have at its disposal. If anything else goes wrong, even with a mobile phone signal, there is no AA for the FOMC.