A less opaque Fed will become boring

The Golden Age of the Fed-watcher is at an end.

Intense interest in the doings of the US Federal Reserve began in the 1970s, as the end of the Bretton Woods exchange rate system led to an era of economic volatility, and interest rate movements became the news that fuelled rapidly globalising financial markets.

There arose a mystique around the US central bank. Like an order of wizards, Fed officials spoke in riddles and did not announce their actions, but left the world to infer them from their consequences in financial markets.

The central bank was the fief of two formidable chairmen: Paul Volcker from 1979 to 1987 and Alan Greenspan from 1987 to 2006. Demand for Fed-watching and analysis grew and grew into a cottage industry that keeps hundreds of economists, analysts and journalists in gainful employment.

But with yesterday’s announcement of an explicit Fed inflation objective of 2 per cent and the launch of forecasts by the Fed of its own future interest rates, there is now far less room for markets to misunderstand the central bank’s intentions.

The chairmanship of Ben Bernanke has meant a last flare of Fed-watching activity, as the central bank launched into bail-outs and quantitative easing, but when economic conditions eventually return to normal its monetary policy intentions will be very clear. The Fed will become boring.

A transparent Fed is likely to be Mr Bernanke’s most enduring legacy, but the process he has set in train may also have another consequence: he may be the last of the almighty Fed chairmen. Greater transparency has unleashed greater democracy within the central bank and the two forces are feeding on each other.

Unlike Mr Greenspan, Mr Bernanke encourages debate and differences of opinion on the rate-setting Federal Open Market Committee, although colleagues still follow his lead. In 2010 and 2011, especially around the time of the $600bn QE2 programme of quantitative easing, those differences began to spill out in public in a way that made the Fed’s overall message confusing.

Part of the response was the Fed press conferences that began in April last year – a way for the chairman to take control of the message – and now the explicit inflation objective and interest rate forecasts.

But the forecasts themselves will make the FOMC more democratic. The Fed now publishes a prediction of interest rates at the end of 2012, 2013 and 2014 for all seventeen members of the committee. On Wednesday, they revealed a huge divergence of views, with three FOMC members suggesting interest rates should rise this year, and two others not wanting to raise them until 2016.

Mr Bernanke took pains in his press conference to say that policy will not mechanically follow the forecasts and the overall decision of the FOMC is still sovereign. But if the forecasts show that most of the committee think rates should rise, then to keep them on hold would make the new communication regime not just meaningless but actively misleading.

The new regime also binds the Fed chairman with rules. No longer can Mr Bernanke, or any of his successors, easily change how the Fed interprets its mandate. The goal is 2 per cent and if the Fed’s forecast is for inflation above or below that, and its unemployment objective does not pull the other way, there will be great pressure to act. That is the point of an explicit inflation target.

All of which makes it ironic that popular anger at the Fed and Mr Bernanke, exemplified by harsh attacks from Republican presidential candidates such as Rick Perry, Newt Gingrich and Ron Paul, has peaked now. Critics accuse the Fed of being arrogant and overbearing and debasing the currency just as it binds its own hands with rules that stop it doing exactly that.

The Fed has probably not yet reached a steady state. The format of the interest rate forecasts may be tweaked. Meanwhile, greater democracy within the FOMC will lead to greater focus on the curious way that regional Fed presidents are selected by local bankers and businesspeople, and reforms to give them greater legitimacy could lead to more democracy still.

The person who truly feels Mr Bernanke’s legacy will be his successor. Unless they are a figure of exceptional authority – a thinker whose economic skills allow them to dominate the FOMC – they may find themselves heir to a diminished chairmanship, observed by a diminished crowd of Fed-watchers.