Episode 9 - Say What?
When Central Bankers speak, the world listens. Their words are analyzed and scrutinized down to the very letter. Why is that? How have their communication strategies changed over time?
I’m Alexander Bagehot, and you’re listening to The Bankster Podcast. This is Episode 9 - Say What? Every episode we dive into the intricate world of central banking! I use one or two pieces of news from the Federal Reserve or monetary policy from around the world to summarize, translate, and explain a few points from the Centralverse. The Centralverse is the deep, the fascinating, the ever changing, and the incredibly consequential world of central bankers and the economies they attempt to support.
When Central Bankers speak, the world listens. Their words are analyzed and scrutinized, often down to the very letter. Why is that? Well, today we are going to discuss the communications of the Federal Reserve. I’ll explain a highly used catch phrase from the Centralverse that was introduced a few years ago - a phrase that most people (even those that use it) don’t fully understand.
But first, one quick announcement. The Bankster Podcast is making its debut on the Apple News App. For all of you that have an iPhone or iPad you can now also find the podcast on the Apple News application that comes built in with every Apple mobile device. If you haven’t heard of the app or don’t know where it is in your phone, just put your finger on the middle of the home screen and pull down. From there you can search, “news” and the app will show up. Once you have it open, search, “The Bankster Podcast”. You may need to scroll down on the channels to find it, but the more people that add the page to their favorites the higher it will climb.
Communication is critical to the success of any organization. Heck, even with my little podcast, I try and be as open and transparent as possible. I also try to make the podcast accessible to as many people and on as many different platforms as possible. Apple News is simply the latest example of my expanding communications strategy. The Federal Reserve has a long history of communication strategies. Ben Bernanke will be remembered as the chairman that tackled the Financial Crisis of the Great Recession. However, almost as important as his contribution to Monetary Policy economics is the shift he directed in the way in which the Central Bank communicates with investors, the public, and with government officials. And this brings us to the news item of the week.
The title of an article in Bloomberg news a few weeks ago read, The “Fed’s [James] Bullard Solves the Mystery of the Missing Dot” Sounds intriguing, right? I immediately saved this article because I knew I couldn’t help but highlight this one during the news section of the podcast. It’s such a perfect example of Centralverse lingo being used as if everybody knew what it meant - when in all reality very very few actually do. The phrase missing dot comes from a document that the Federal Reserve’s FOMC, the policy setting committee, publishes every few months. We’ll go into more detail about the history of and need for the Dot Plot in a few minutes, but first, let’s answer the question - What is it?
Let me try and describe to you what the most recent Dot Plot looks like. It is a simple graph with four clusters of dots. The horizontal axis is time, so as you go from left to right it reads, 2016, 17’, 18’, long-term. The vertical axis is interest rates, so as you go from the bottom to the top the interest rate gets higher. The clusters, one in each time period, make different shapes. To keep the visual going so you can follow along with me, one looks like a paper boat, another a stealth airplane, a dreidel, and a ufo. As you go left to right each cluster gets a little higher than the previous.
Traditionally, each cluster is made up of 19 dots - hence the name the Dot Plot. The dots each correspond to one of the members of the FOMC. Remember who they are? Each president of the 12 Reserve Banks dispersed throughout the country and all 7 of the Governors in Washington make up the FOMC. Approximately every three months, or every other meeting, each member of the FOMC, whether they are voting that year or not, place a dot on this graph. Each dot represents where that particular member believes the median of the Federal Funds target range should be at the end of the given time period.
For example, the 2016 time period on the most recent Dot Plot shows six dots at 0.63%, nine dots at 0.88%, and one dot each at 1.13% and 1.38% (this makes the little paper boat looking cluster). Remember that currently the median is 0.38%. Then to the right of this cluster are three other clusters of dots corresponding to each member’s thoughts for each of those time periods. Are you beginning to see the significance of this chart? It shows what the individual members of the committee believe the appropriate timing of the increases in interest rates should be. This is like a peek into the minds of the committee members.
Now, if you were counting up the dots as I described them to you would have noticed that I only mentioned 17, not 19. This is how many dots are in the first three clusters and the reason is not very exciting - in fact, it’s a somewhat depressing reminder of the inability of the Senate to work with President these days. The two missing dots are the two missing members of the Board of Governors. There are some lingering disagreements that maybe we’ll talk about later that is holding up the political process, but for now that’s the simple explanation for those two missing dots.
However, the mystery that the Bloomberg article was referring to was not those two missing dots but rather it was related to the “long-term” cluster. In that one there were only 16 dots. Rumors flew for about a day and half when the Dot Plot was released until James Bullard, President of the Federal Reserve Bank of St. Louis, released a detailed statement explaining why he has decided to stop participating in the traditional Dot Plot exercise. In the opening paragraph President Bullard directly references the underlying purpose of the Dot Plot - communication.
He says, “An older narrative that the bank has been using since the financial crisis ended has now likely outlived its usefulness, and so it is being replaced by a new narrative.” I won’t go into detail about what his new outlook is, maybe we can talk about varying high level economic outlooks in a future episode. For today’s episode it’s critical to understand that the Dot Plot is a form of Centralverse communication and underlying this change in thought by Bullard is a change in his philosophy towards the central bank’s communication strategy - it’s as simple as that.
So now we are going to wind the clocks back just a few years and see where this Dot Plot chart fits in in the ever evolving communications of the Federal Reserve.
The Fed’s Communication History (in brief)
While researching this topic I was surprised that I could not find a nice timeline outlining some of the big shifts in communications from the Federal Reserve or other central banks from around the world. This is such a critical tool that central bankers use that I thought surely someone would have created a nice chart; however, I found no such thing. So I decided to begin one myself. I don’t have it all the way developed or outlined, but I’ll discuss some main steps that would surely be featured in the last two decades or so. I’ll put up the timeline rough draft on my website as well as provide a summary on the show notes that accompany this episode. Remember that you can sign up for those at www.thebanksterpodcast.com.
At this point I’d best begin using the Centralverse term central bankers use when describing the communication strategy as a monetary policy tool. The term is - Forward Guidance. It’s somewhat cryptic as nearly all Centralverse (and financial) lingo generally is; however, the principle is summarized quite nicely within the term.
See most of the time central bankers affect the economy by doing something directly to the economy. For example, as we discussed in Episode 5, they may buy treasury bonds on the open market, by which increasing the amount of dollars in the banking system, thereby decreasing that lowest of interest rates - the Fed Funds Rate. That’s something the central bank can do, but what happens when the central bank has done all that it feels it can do? Well, it can tell the economy (meaning bankers, businesses, government, and investors) what it plans to do. These are nothing more than words, but words from people with such power over the future of the economy are worth listening to.
Do you remember from Episode 1 what Marriner Eccles, the president of a bank in Utah, said right after he, with help from the Federal Reserve, had calmed the panicked bank run? He said, “The mood of the day was so unreasoning that men were heartened by words as meaningless as those which caused them fright.”
Eccles was right and wrong here. He was right to observe that the words that he had spoken while standing atop the bank counter did hearten the people terrified that they were going to lose all of their money. However, he was wrong to say that those words were meaningless. In fact, all of the actions of central bankers are watched very closely.
There was a funny theory related to this called the The Briefcase Theory that circulated a few years back when Alan Greenspan was the chairman of the Federal Reserve System. People watched the FOMC meetings so closely that some said that the size of the briefcase that Greenspan took into the meeting foretold the policy decision of the committee that day. If the briefcase was full and wide, the theory went, the chairman was bringing lots of evidence necessary to make the case for an increase in interest rates. If the briefcase was thinner, the chairman must not have much to discuss and the interest rate would stay the same. Sounds silly, right? Well, these interest rate decisions literally move financial markets and change the direction of the economy, so any information investors can glean ahead of time can literally be money in their pocket.
The silly Briefcase Theory was popular at the end of the 90’s, so it’s unsurprising that the Fed began their increase in communications shortly afterwards. At the February 2, 2000 meeting of the FOMC the committee decided to begin issuing statements at the conclusion of the meeting. The statement publicized the interest rate decision that would take effect the following morning. It also gave a brief explanation for why the committee had made the decision they did. It would take quite a few more years and an economic crisis the likes of which had not been seen in the United States for over 70 years for the next communication move to come to the Federal Reserve.
So before we talk about the next communication move let’s talk a little bit about the build up - what did it take for the Fed to need to fully embrace Forward Guidance as a policy tool. Well, the Financial Panic of 2007-09’ quickly devastated the US and then the global economy.
Bernanke’s Fed took action as quickly as they could (and unfortunately a little late). They began lowering interest rates in September of 2007 and kept lowering them until they hit zero in December of 2008. They sponsored a rescue of Merrill Lynch and Bear Sterns (two large investment banks) and AIG (an insurance firm). They attempted to rescue Lehman Brothers (another investment bank). In November of 2008, the central bank recognized that they had nearly arrived at the lower bound of zero interest rates (we can talk about negative interest rates at another time, which on a broader scale wasn’t done back in those times) the Fed announced what would be its first of three Quantitative Easing programs. These were basically a different method of putting money into the banking system on a large scale.
After using up all of the classic tools that the central banks normally have at their disposal, Bernanke decided to put to test what Eccles had experienced 80 years previously in a small town 1000’s of miles to the West - he would try and use words to brighten the outlook. He hoped that the words that he spoke about the future actions that the Federal Reserve was planning to take would calm the economy. Here’s how it happened and the evolution of Forward Guidance that led to the Dot Plot.
In April of 2011 Bernanke held the first ever scheduled, live press conference following the FOMC meeting. He read the statement, expounded on his thoughts of the recent monetary policy, and then took questions from reporters. For an institution with a history of tightly closed doors, this was a giant step in opening up.
Included with the statement of this same meeting was additional attachments. These attachments were called “Projections” and they included forecasts of economic growth, unemployment, and inflation for three following years and the long-term. The projections outlined only the range of forecasts, and not each member of the FOMC’s individual forecast.
In the June meeting of that same year, so just a few months later, the Fed added to the projections a line chart showing a five year history, and then the line fanned out to show the range of projections that the committee members had for the future.
In January of 2012 the Fed added an additional two charts to the ever lengthening projections. The first was called The Appropriate Timing of Policy Firming, which was a bar chart showing when each of the committee members believed the Fed would start increasing interest rates. The second chart was what would become known as, drum roll please, The Dot Plot. The official name is much more Centralverse-y, The Appropriate Pace of Policy Firming, but Dot Plot is much more palatable. If you follow along in the Centralverse you’ll hear this term used over and over again - or at least every three months or so when the Fed releases another one. So now you know not only the history of where it came from, but hopefully you understand why the Fed uses it. Simply put - it’s a part of their Forward Guidance.
And, at least during times of economic uncertainty, it is just as important a policy tool as the control of interest rates. And for the foreseeable future, the Dot Plot is going to be a big part of the Federal Reserve’s Forward Guidance.
In the next episode we are going to continue our conversation on Centralverse communications. I’ll describe imminent crisis communication from central banks. I’ll describe three experiences with Centralverse communication. I’ll highlight the story behind the communication of the Federal Reserve on 9/11 and more recently, how central banks from around the world reacted to Brexit. Shout out to AliEmme, who sent in an email asking about Brexit. We’ll talk about the Centralverse’s reaction next time. We’ll also dive into an event from the recent past and see how a few simple words spoken by a Fed official at a lodge in Wyoming sent the financial world spinning.
If you have comments, recommendations, or questions about the The Bankster Podcast or the Centralverse in general, you can email me, email@example.com. At my website you can find a transcript of today’s episode with links to all of the sources I used in creating the content, including the rough draft of the communications timeline. And I encourage everyone to go to the website, scroll to the bottom of the home page and sign up to receive each episode’s show notes and the bonus book suggestion - which you’ll find in your mailbox a week from today.
Today’s episode was written, edited, and produced by me, Alexander Bagehot. I dedicate this episode to Joshie. I couldn’t have asked for a better bunk mate. GLS buddy! And to all of you, thanks for listening. I’m Alexander Bagehot, and I’ll see you next time on The Bankster Podcast!