Federal Reserve mystifies its policymakers sometimes

Friday, August 29, 2003

WASHINGTON -- Like thousands of investors and analysts, William Poole, president of the St. Louis Federal Reserve Bank, wonders how financial markets will react after Fed officials meet to set interest rate policy and issue a statement explaining their decision. Poole, who is one of the policymakers, conceded in a speech last week that he often guesses wrong.

In recent months, so many of Poole's colleagues, including Fed Chairman Alan Greenspan, have guessed wrong about the public response to their actions and words that the bond market, owners of mortgage-backed securities and many homeowners seeking to refinance their mortgages were whipsawed when longer-term interest rates plummeted and then snapped back.

The result, according to a number of economists and former Fed officials, has been at least some loss of Fed credibility and a heightened uncertainty about the central bank's policy intentions in the coming year. The episode, some economists believe, has left rates, such as those on fixed-rate home mortgages, higher than they otherwise might have been -- and therefore a drag on growth. The refinancing boom, a critical source of support for consumer spending and the economy, has already been choked off.

Many investors and analysts wonder whether Greenspan will address the issue when he speaks tomorrow at a Fed conference in Jackson Hole, Wyo. His topic: "Monetary Policy and Uncertainty."

Poole said in his recent speech: "My personal experience is that I find it exceedingly difficult to predict how people will interpret policy actions and the nuances of the press release."

A key misreading of Fed intentions occurred in May, Poole noted.

Economist Alan Blinder of Princeton University, a former Fed vice chairman, agreed that something went badly awry this spring.

"I think something did go wrong in communication," Blinder said. "There was some fault on both sides. The Fed folks need to understand that bond market generally overreacts to their words." But Fed officials do understand that, he added, which leaves all that happened somewhat mystifying.

The Fed's problems began in the weeks leading up to the policymakers' May 6 meeting, as Greenspan, Fed Vice Chairman Roger W. Ferguson Jr. and Fed Governor Ben Bernanke, in speeches and congressional testimony, began to discuss the dangers of deflation in a slow-growth economy. They said the probability of deflation was "remote," but their detailed discussion of the issue made a strong impression in the markets.

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