It is an attractive idea. Yet there are three reasons why it is not clear that Warsh’s classical view of monetary policymaking is realistic in the contemporary financial system – if indeed it ever was.
First, while the textbooks claim that financial markets price underlying economic fundamentals, investors know full well that they just as often reflect rank speculation as to what other market participants think. “We devote our intelligences to anticipating what average opinion expects the average opinion to be,” as the economist John Maynard Keynes put it; “And there are some, I believe, who practise the fourth, fifth, and higher degrees.”
Secondly, Keynes was writing when financial markets were the exclusive preserve of a professional elite. In the era of online trading apps like Robinhood Markets, zero-day-to-expiry options, prediction markets, and 24-hour trading, it is even harder to believe that today’s investing public are going to stop speculating how the central bank will react to economic events, regardless of whether it chooses to spell it out. Moreover, Keynes did not have to contend with the social media revolution which has made demands for instant accountability an unavoidable fact. When the U.S. president regularly addresses voters unfiltered via his smartphone, it is no longer viable to think that the country’s financial overlords can make policy without explaining themselves directly too.
Warsh’s plan also suffers from a final financial conundrum. The fixation of investors on policymakers’ intentions may indeed make it harder for central bankers to calibrate their policy accurately. Ironically, that obsession is also essential if policy is to have its desired effect. This is the paradox that then Bank of England Governor Mervyn King captured in his famous comparison of successful monetary policymaking to Argentinian football great Diego Maradona’s “goal of the century” against England at the 1986 soccer World Cup. Maradona dodged five defenders despite running in a straight line because his opponents expected him to deviate. King argued that only by luring investors into anticipating what it would do if circumstances demand that a central bank can achieve its objectives efficiently. “Not only do expectations about monetary policy matter,” as Michael Woodford, the guru of twenty-first century monetary economics, once summed it up, “at least under current conditions, very little else matters.” King’s views are likely to count: Warsh has appointed him to advise on the Fed’s communications.
Warsh is quite right to fear the descent of modern monetary policy into an unseemly postmodern morass. Yet in the digital age, the circular flow of information is the water in which we swim. The key to avoiding a communications breakdown is not silence but constructive ambiguity. As the soccer pundits say: don’t just shut up shop - keep your opponents guessing.
SPY•
