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Despite its efforts to increase transparency, the Federal Reserve seems to be getting more and more complicated for outsiders especially in regards to monetary policy.Even the statements and minutes of its Federal Open Market Committee (FOMC) meetings rarely tell the whole story of what the Fed officials are really thinking.
Indeed, to better understand the Fed, you need to follow the countless numbers of speaking engagements and interviews that the Fed members make in between the FOMC meetings.
Vincent Reinhart, Morgan Stanley’s Chief U.S. economist, explains why this is so in a new note to clients. Few people have a better understanding of how the Federal Reserve works than Reinhart, a former Fed insider.
The Fed’s failure to communicate internally owes to an irony of increased openness. In 1994, under considerable Congressional pressure, the Fed became more transparent. One initiative was for historians. The FOMC decided to release lightly edited, but otherwise complete, transcripts of every meeting, five years after the fact. 1
What followed was a predictable social dynamic that is never factored in by economists in their theoretical reasoning that more transparency is better. Starting that year, speakers at an FOMC meeting were given a rough draft of their remarks a few weeks after each meeting. Most learned, to their surprise, that they were a lot less lucid speakers than they had imagined. Off-the-cuff responses to prior speakers looked unthoughtful in black and white. Almost immediately, some began bringing prepared remarks. This set off a readiness race that ended with virtually everyone reading from prepared texts.
Meetings got longer and less spontaneous. More problematic still, meetings became a less useful way of exchanging information and changing minds. This led to a new dynamic: When policy views are scripted, the window to influence views opens before the meeting, when scripts are being written, not during the meeting, when scripts are being read. Thus, Fed officials give more speeches and interviews before meetings to signal each other what they will read at the meeting. If a policy issue is contentious—if it is a close call—then the volume cranks up. It just so happens that the free investing world is listening to that conversation.
Indeed, some weird but often humorous stuff comes up in those transcripts. In January, the Fed released the transcripts of the 2006 FOMC meetings and they were much more entertaining than you would expect.