Musalem: Framework key to Fed communication strategy

From the St Louis Fed president:

• An open and predictable framework is a key component of a central bank's democratic legitimacy.
• When the public grasps the framework, their expectations align with the Fed's goals, improving the trade-off between inflation and employment.
• A framework that is effectively communicated also helps prevent inflationary and deflationary spirals.
• The Federal Reserve's delegated authority over interest rates also requires it to explain 'how and why that power is used'.
• Market guessing 'adds noise,' leading to higher and more volatile interest rates and financing costs for businesses and households.
• The 'hall of mirrors' happens when the Fed publishes a forecast rather than a framework.
• Communicating the framework enhances policy effectiveness and reduces costs for households and businesses.
• If a central bank keeps its framework internal, market participants must guess about its reactions instead of focusing on data.
• Central banks should avoid communications and actions that lack a framework for understanding them.
• They should also avoid 'exiting the conversation altogether,' which would pose inflation risks.
• A well-articulated framework ought to include two or three likely scenarios.
• Central bankers need not make promises, but they should explain how and why the central bank makes policy decisions.

St Louis Fed President Alberto Musalem delivered a speech on central bank communication, but it contained nothing tradeable as it was a philosophical lecture.

Musalem contends the Fed ought to communicate a reaction function instead of a forecast, cautioning that releasing forecasts produces a 'hall of mirrors' where markets and policymakers pursue each other's projections. This is a barely disguised criticism of the dot plot and forward guidance that commits to a path without explaining the underlying conditions.

The remarks also largely mirror early critiques of Warsh's communication approach, which appears to have evolved. He warns against 'exiting the conversation altogether,' stating that would create inflation risks. This seems like a rebuttal to those who advocate the Fed speak less and depend less on guidance. Musalem's proposal is a compromise: present two or three plausible scenarios, make no commitments, but clarify the how and why.

While these ideas are all reasonable, it is unclear how this major 'change' at the FOMC will result in anything new. The Fed already talks extensively and answers queries, which is sufficient for the market.