Central bankers must recognize their shortcomings in a less secure world, says Fed Chair Loretta Mester.

Central bankers must recognize their shortcomings in a less secure world, says Fed Chair Loretta Mester.
Central bankers must recognize their shortcomings in a less secure world, says Fed Chair Loretta Mester.

For nearly 40 years, Cleveland Fed President Loretta Mester was part of a revolution that saw the U.S. central bank offer increasingly detailed and profuse commentary on the economy and monetary policy.

As she prepares for her mandatory retirement in June, the Cleveland Fed president has one final thought: With an economy in flux as a result of the COVID-19 pandemic and with uncertainty surrounding even aspects fundamental to the functioning of the economy, precision can be an enemy.

Markets certainly want to know exactly… “when are you going to cut rates?”. That’s what they’re focused on,” Ms. Mester, 65, said in an interview with Reuters on the sidelines of an Atlanta Fed conference this week. “The public … doesn’t want not hear a lot of complicated things. He wants to know what he really thinks.”

“We have become much more transparent over time,” she added, but “we are not forward-looking. We don’t know exactly how things are going to happen… If the economy develops differently than this that you expect, and in a significantly different way, … your policy must respond to it.

Given the magnitude of the unknown, she said the Fed should incorporate more of that uncertainty into how it talks about policy, focusing less on basic or “modal” outlooks and more on a handful of most likely outcomes – or scenarios – that would help the public better focus on how policymakers would respond when the economy, as it inevitably will, does something different than expected.

“If you only communicate the modal vision, you are poorly communicating your real vision of the economy to the public,” Ms. Mester said, referring to economic projections made at the start of the pandemic as an extreme example of how any perspective is based on series of assumptions that, she says, are becoming increasingly difficult to formulate.


Ms. Mester is retiring before the Fed conducts a review, expected to begin later this year, of how the central bank sets policy, the tools it uses to implement its decisions and communications strategy – an area that she believes requires special work.

The Atlanta Fed conference, held this week in Amelia Island, Florida, focused on some of the questions the central bank wants to answer about the post-pandemic economy, showing a sense Shared among policymakers that the coming era, coupled with changing trade relationships and volatile geopolitics, could prove difficult for central banks to manage.

David Zervos, chief market strategist at Jefferies, argued, for example, that the Fed’s reliance on bond buying during the crisis may be one of the elements that blunted the final impact of the monetary policy when rates began to rise, because it imported losses into the Fed’s balance sheet that would otherwise have been borne by the public and which depressed spending.

Others looked at how the U.S. housing market might soften the central bank’s impact instead of amplifying it, as has been the case in the past, and warned that Extensive economic support measures implemented by the Fed during the pandemic could reset the baseline for what it would be called upon to do during the next shock.

“This is an active discussion … about how we need to look at the long term,” Raphael Bostic, president of the Atlanta Fed, said in an interview with reporters on the sidelines. of the Amelia Island Conference. “We know there have been changes because of the pandemic, in the way labor markets operate, in terms of supply chain diversification, and all those things that could change the baseline level of energy in the economy.

Analysts will try to understand how this will play out in the long term.

But monetary policy is responsible for stabilizing prices and employment in the short to medium term, an exercise that traditionally focuses on demand management, as it is the aspect of the economy most immediately influenced by interest rate, which is the cost of borrowing money.

However, it also depends on how the economy is expected to evolve over time, and this calculation becomes complicated if elements such as productivity, the neutral interest rate or the probability and impact of supply shocks are not relatively stable or, at least, if they do not evolve in a familiar and somewhat predictable way.


According to Ms. Mester, the pandemic essentially cast central bankers in the role of epidemiologists and virologists – which is far from their specialty – since any plausible outlook for the economy depended on assumptions about infections, variants viruses and vaccines.

Likewise, she added, if policymakers can no longer assume that supply shocks fade quickly, for example, or if they see that the economy responds differently than before at a given level of interest rates, economic modeling and projection lose their basis.

“This increases the level of uncertainty and we therefore have to become much more agile. How can we organize ourselves to be well positioned whatever the situation evolves? Ms Mester explained that the initial hypothesis that the increase in inflation in 2021 would be “transitory” delayed interest rate hikes that it said could have started earlier and proceeded with less risk and dramatic effects.

Better communication about the Fed’s level of ignorance could help avoid this type of error in the future by discussing, in every general policy statement or in less frequent documents such as the semi-annual monetary policy report at the Congress, the most likely economic scenarios and the “response function” that Fed officials would use to respond.

Getting the Fed’s disparate group of seven governors and 12 Reserve Bank presidents on the same page about this approach could be a challenge, Ms. Mester acknowledged. But she said the central bank’s credibility would be strengthened if it were frank about the range of possible outcomes rather than allowing more specific expectations to develop and then turn out to be wrong.

“Let’s choose three notable scenarios. There will be one that will probably carry a little more weight […]. Here’s what we think will happen. Here’s what we think will happen. However, we have these alternative risks.

“It’s not a trivial thing to do,” she said, but “it can only enhance your credibility.”



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