Wednesday, December 14, 2005

Is a little uncertainty sometimes a good thing?

I was reading today that Ben Bernake, the nominee for Chairman of the Federal Reserve, will be speaking at MIT's commencement this year. Mr. Bernake has a strong reputation for intelligence and for challenging conventional wisdom. In describing his economic philosophy, they quote him saying, "You want to release information that helps the market and the public achieve more accurate expectations of future policy and the future state of the economy."

If we're going to challenge conventional wisdom, how about we look at the idea that more information is better? Does maintaining a transparent monetary policy really help? In most policymaking cases, knowing more information is better because you can better discern the potential outcomes of the policy and, more importantly, judge the hidden agendas of stakeholders.

However, during his tenure as Fed Chair, Alan Greenspan was notorious for opacity. His speeches and congressional testimony were analyzed like Kremlinologists used to analyze the Soviet Union. While Mr. Greenspan kept people guessing, Mr. Bernake instead believes that clearer statements will allow people to make better predictions and have more confidence in the future.

But what happens when people get too confident in their predictions for the future? After all, a good prediction is still a prediction, and thus prone to be wrong on occasion. If people have too much confidence in their prediction, they can put themselves at risk of drastic loss if those predictions fail. Perhaps a little opacity keeps people on their toes and makes sure that they hedge their bets just to be safe?


At 9:17 PM, Blogger Thomas said...

Actually you statement about Greenspan being notorious for opacity is completely false. One of Greenspan’s legacies is opening up the Fed. While Bernake is even more open I would hardly consider Greenspan notoriously opaque. He has never kept his intentions secret - I can see why people think that he is being opaque because of his tendency not to commit to any one economic indicator he is watching. This really is a good thing since it gives him flexibility. He comes out and says I am going to tighten until I can get inflation under control – Then People will scan his speeches for the smallest wording changes to see what is on his mind but if you step back and read his speech instead of the words in his speeches he tells you exactly what he is doing. In the same vein I highly doubt that Bernake is going to come out give specific numbers and blindly follow them. He is just going to be a little more open with what he is looking at as indicators but I am sure he is going to keep the same paragraph in his speeches that Greenspan does (the most important paragraph) that the Fed will change their policy to reflect changes in economic conditions… I will stop now.

At 9:35 PM, Blogger Dan Craig said...

You're probably right about that, but he was certainly perceived to be opaque, and many articles and editorials in the media bear this out. But whether or not he was truly open or truly opaque, the question about uncertainty in decision making is still valid.

At 1:34 AM, Blogger Anthony said...

It's all relative -- Greenspan effectively told the market he'd tighten money supply by 25 bps at a time by using the word "measured". However, you could also argue that he's being opaque by not disseminating exact inflation targets. Greenspan's broader message was that inflation matters and monetary policy will be used to control it.

Bernanke comes from the same school of thought but he's actually mentioned setting explicit inflation targets (or at least ranges). The problem is what you do if inflation goes beyond the "target" numbers and how the markets will respond. There are arguments to both sides -- it will be interesting to see what he does at the first Fed meeting that he chairs. If the yield curve is still flat or slightly inverted or if the equity markets are struggling I think he'll face a tough choice.

At 3:36 PM, Blogger Thomas said...

did some more thinking on this.. I like a bit of uncertainty. Not coming right out with exact targets really gives you some flexibility to change your mind without breaking any "promises" that the markets price in. Though the markets will price in whatever they want... so who knows. should be interesting


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