The Fed Needs to Explain Itself Better

Jared Bernstein is a senior fellow at the Center on Budget and Policy Priorities in Washington and a former chief economist to Vice President Joseph R. Biden Jr.

The nomination of a new chief of the Federal Reserve seems a fine time to step back a pace and look at some crucial issues on the role of the Fed with an eye to making a good institution even better.

In case that “good institution” threw you, let me elaborate.  In an era where almost every societal institution I can think of has been failing, the Federal Reserve stands out as a notable exception.  The government sector is a bad joke right now.  Corporate America is widely viewed as giving up on America in the pursuit of global profit.  Fundamental aspects of democracy â€" voting rights, the independence of the Supreme Court, equal opportunity and mobility â€" are in doubt.

Yet the Fed, largely by dint of its designed independence from political pressure, continues to pursue its mandates of stable prices, full employment, and oversight of the banking system.  It has, of course, made big mistakes.  Critics, including myself, are always arguing about whether it is being too hawkish (overweighting inflation concerns) or dovish (overweighting employment concerns), and the economy is still suffering from the fact that it missed the housing bubble, a truly egregious error, though one made by most economists.

But that was an analytic error, not an institutional one, and the Fed clearly has the capacity to self-correct, whereas a characteristic of failing institutions is the inability to do just that.

First things first: the Senate needs to quickly approve Janet L. Yellen to replace the departing chairman, Ben S. Bernanke.  This shouldn’t be a problem, but nothing’s a slam dunk these days.  Remember, the Senate essentially rejected the nomination of the Nobel laureate Peter Diamond to the Fed board, because Senator Richard Shelby, an Alabama Republican, didn’t think he had “the appropriate background or experience.”

There’s already chatter that Ms. Yellen’s too much of a dove.  That’s just wrong, and a symptom of tuning into her actions only since the Great Recession, when she’s worked with Mr. Bernanke to apply aggressive monetary stimulus.  To label her a dove in that setting is like criticizing a firefighter who’s spraying water on a blazing building for being an obsessed hater of flames.  She’s doing her job.

And her record shows that she’ll do that same job in reverse if she believes inflationary expectations are growing unmoored.

Of course, if she is confirmed, one of the challenges Ms. Yellen will face is the dysfunction of the very body that’s confirming her, a point made by the economist Chad Stone.  Interestingly, the nature of this dysfunction has implications for her work: the anti-growth bias of the current and at least near-future government (for example, the imposition of fiscal headwinds without regard for existing output gaps) means the neutral federal funds rate â€" the interest rate that balances inflationary and employment pressures â€" is probably lower than in more normal times. So I take comfort in the fact that her record shows her to be data-driven, and neither hawk nor dove.

The other challenge she faces is a much broader one that the Fed has faced forever: most people don’t know enough about what the Fed does.  That may have been all right in the past, but it’s problematic today.  Let me elaborate by way of anecdote.

I was recently on the road giving talks about the economy and the political mess.  When I talked about the Fed in the spirit of the above, I typically got two reactions.  One was mostly from people worried about jobs, wages and incomes, who didn’t see how a new Fed chief was going to make any difference in their economic lives. The other was from people worried about their portfolios of stocks and bonds, who felt the Fed, with its balance sheet extended by trillions in recent years, was just too much of a presence in the market, skewing price signals and creating uncertainty.

Not good. The people whom the Fed has been trying to help don’t know it or see it, while the stuff that the Fed is doing is increasingly viewed with rancor by market participants who scrutinize their every move.  Clearly, there’s a downside bias at work here.

To put the problem another way, consider this. It is my privilege to be a contributor to both CNBC and MSNBC, the former providing financial news aimed at markets, the latter (at least in my segments) political economy analysis aimed at progressives. Yet the Fed’s actions are a constant topic on C, but a rare one on MS.

One perverse outcome is that people, especially market participants, have come to believe that markets are the Fed’s primary target, if not its sole one, when in fact, it’s the real economy â€" jobs, inflation, unemployment â€" that is the ultimate target.  Financial markets are by no mean incidental, but especially in downturns, those markets are intermediaries through which Fed actions are intended to help average, working families.  The tail does not wag the dog.

One saw this dynamic in play quite clearly a few weeks ago when the markets were completely surprised by the Fed’s decision not to start tapering off its asset buying program. Yet to those of us watching the real data, which were pretty blah, along with the impending government mess, which would also impinge on growth, its move made total sense.

So, what might a Fed under new leadership do to help more people understand what it’s up to and whose interests it is working for? It’s not an easy question, because Mr. Bernanke was quite good at explaining how his Fed was taking aim at the unemployment rate, beseeching Congress to blow fiscal tailwinds that would complement the Fed’s monetary stimulus, instead of the headwinds that have rendered the Fed’s low interest rates less effective.

But maybe the problem is less the message than the audience.  With few exceptions, Mr. Bernanke spoke only to Congress, markets and economic elites. He held forth at Davos and Jackson Hole â€" not exactly Main Street.  I think it would be great if Ms. Yellen and others got out more among the people.  Speak at the hunger conference I attended the other day; talk to the Head Start administrators I met with last week.  Sure, speak to the Chamber of Commerce, but speak to the unions, too. (Ms. Yellen actually did so a few months back, but that’s the national coalition; I’m also talking about the locals).

Talk about the role of Fed interest rate policy, and more recently, its asset purchases, in holding down the cost of loans, including mortgages. Talk about the Fed’s favorable impact on exchange rates, and thus on our manufacturing sector, as low interest rates make our exports more competitive in foreign markets. Talk about how the Fed has been contributing to lower budget deficits by turning the profits on its bond portfolio over to the Treasury, to the tune of around $80 billion a year in recent years.

Since 2010, when Congress pivoted first to deficit reduction and then to gridlock, the only large, influential institution in Washington focusing on reducing unemployment and getting this tepid recovery up to speed has been the Federal Reserve. Yet the beneficiaries of those actions know very little about them. Outsiders like myself can help, but it will take a commitment by the Fed itself to really change that.