Making Monetary Policy Make Sense

If content is king in mass media, context is the power behind the throne.

With the Federal Reserve Board’s Federal Open Market Committee set to meet at the end of the month, speculation is again heating up on the likelihood of a cut in interest rates. And a prime source for those rhetorical flights of fancy is the Fed’s semi-annual policy report to Congress.

Formerly known as the Humphrey-Hawkins Report, twice a year the central bank is required under the Full Employment and Balanced Growth Act of 1978 to provide Congress with an update on Fed activity and the state of the economy.

While commentators, columnists and armchair economists pick over the 79-page document, they skip over the part where the Fed tries to explain what it is trying to do with monetary policy. That’s where you find the context for Fed policy and more than a little insight into how and why monetary policy affects the economy, the equities markets, balance sheets and bank accounts.

But the “news” produced in response to the Fed’s release of the report generally lack that contextual framework and many business writers take it for granted that consumers understand the workings of the central bank. They will often include a quick mention of the Fed’s so-called “dual mandate” of price stability and maximum employment without defining what that means.

It’s assumed everybody knows that the Federal Reserve does and therefore common knowledge like how compound interest works or the infield fly rule.

But in its rush to dissect the Monetary Policy Report, the financial media skips over the introductory section of the publication where the Fed defines its mandate and why it is difficult to precisely calculate when and why to raise or lower interest rates.

For example, in the section on “maximum employment,” the Fed admits the concept is “not directly measurable and changes over time” and therefore there is no fixed goal for employment. Instead, interest-rate decisions “are informed by assessments of the shortfalls of employment from its maximum level, recognizing that such assessments are necessarily uncertain and subject to revision.”

In other words, it is more or less a guessing game when it comes to employment. And the reasons behind the 2% inflation goal are even more opaque, with no explanation of why that particular number was chosen instead of 2.5% or 3%.

Without that context, it is difficult for ordinary people to understand why interest rates are high today and even harder to appreciate what will motivate Fed policymakers to make a change. But the reporting will focus almost exclusively on if and when the Fed will lower interest rates.

It’s like putting together a piece of furniture with no instructions or even a picture of what it’s supposed to look like. Without a frame of reference or context, reaction to whatever the Fed does next may not look the way it does on the financial pages.