In the intricate ballet of central bank policy, clarity in communication is paramount. The better the Federal Reserve’s messaging, the more accurately market participants can gauge how policies might shift in response to economic conditions. Unfortunately, the Fed has fumbled this crucial element, leaving markets scratching.
Fed Chair Jerome Powell has hinted that revising the central bank’s communication strategy will be part of its 2025 monetary policy overhaul—a commendable idea, given the current state of affairs. After all, the Fed’s words shape market expectations about future interest rate moves and directly influence financial conditions, the lifeblood of monetary policy transmission.
While the Powell-led Fed has generally earned decent marks for its communication—scoring a respectable B+ in a 2024 Brookings Institute survey—recent critiques highlight glaring missteps. Last month’s press conference was a prime example, as Powell announced a rate cut amidst projections of robust economic growth and higher inflation for 2025. The resulting cognitive dissonance was palpable, baffling analysts and market players.
The Fed’s much-touted “flexible average inflation targeting” framework has proven to be less than illuminating. Officials haven’t specified the period over which this mythical “average” applies, nor clarified how far above 2% inflation they’re willing to let things run to make up for prior shortfalls. Powell’s suggestion of ditching this framework entirely in favour of a simple 2% inflation target would have the virtue of being straightforward. It might also curb the Fed’s apparent reluctance to tighten policy after prolonged periods of undershooting its inflation goal.
The Fed’s Summary of Economic Projections (SEP), the cornerstone of its communication arsenal, is riddled with holes. One glaring flaw is the lack of a shared baseline for FOMC members when making their projections. As Powell himself admitted during last month’s press conference, some members incorporated the anticipated effects of President-elect Donald Trump’s policies into their forecasts, others didn’t, and some conveniently declined to clarify either way.
Even more confounding is the disconnection between projections for economic variables like GDP, unemployment, and inflation and the corresponding interest rate forecasts. Are differences in rate projections due to divergent economic outlooks or varying interpretations of how the Fed should react? The SEP doesn’t say, leaving markets to play a frustrating guessing game.
The Fed’s messaging around quantitative easing (QE) and quantitative tightening (QT) has been equally muddled. Clear guidance on when QE should be used to stabilise markets or stimulate the economy, especially when short-term rates hit the lower bound, remains elusive. Similarly, there’s no explicit cost-benefit framework to help markets assess how evolving economic conditions might influence the scope and timing of QE or QT.
A robust communication strategy for these tools would enhance market understanding and strengthen the Fed’s ability to influence financial conditions, a key transmission channel for monetary policy.
Effective communication is not a luxury for a central bank; it’s a necessity. When the Fed stumbles in this regard, it risks undermining the link between its policy actions and financial conditions, slowing and complicating monetary policy transmission.
In a world already fraught with economic uncertainty, the Fed’s mixed messages are the last thing markets need. If Powell and his colleagues are serious about tightening the Fed’s communication game in 2025, they’d better start now—before more clarity gets lost in translation. So far, the market conclusion indicates that the FOMC appears divided, with no clear leader guiding the direction amid unstable conditions.