Tags: Cohen | interest | rate | uncertainty

Brookings Institution's Cohen: We Need More Uncertainty About Interest Rates

By    |   Thursday, 01 May 2014 12:37 PM

Uncertainty about interest rates isn't a bad thing, says Gerald Cohen, Senior Fellow in Economic Studies at the Brookings Institution.

What we really need is more uncertainty about rates as the Federal Reserve tapers its asset purchases, Cohen writes in a blog.

As Cohen sees it, the Fed should stop fretting about trying to provide the market certainty and admit it just doesn't know where rates are headed down the road.

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Greater certainty is great to contain crisis, he explains, but once the economy recovers it can promote unnecessary risk taking and greater volatility.

Some economists believe U.S. economic growth has permanently slowed, but recoveries following financial crisis are historically weaker that other recoveries are, Cohen notes.

"Now it seems that the headwinds from the financial crisis are diminishing and the economy is about to take off."

To create more uncertainty, the Fed should publish "fan charts with probability distributions of economic outcomes" like those released by the Bank of England, he argues. Fed officials should point out those distributions in their speeches and testimony.

"If the Fed starts telling people that they don’t know how the data will evolve, the market will get the picture."

The Fed has been "trying to create a false sense of security about the path of interest rates," although Fed Chair Janet Yellen did introduce uncertainty in a recent speech to the Economic Club of New York, he proclaims.

In that speech, Yellen praised the benefits of being both flexible and providing certainty.

"While monetary policy discussions naturally begin with a baseline outlook," she stated, according to prepared remarks, "the path of the economy is uncertain, and effective policy must respond to significant unexpected twists and turns the economy may take."

The Fed would actually increase uncertainty about its decisions by tying them to economic changes.

"But by responding to changing circumstances, policy can be most effective at reducing uncertainty about the course of inflation and employment," Yellen noted.

Under Yellen, the Fed has dropped the benchmarks it used under former Chairman Ben Bernanke. As The Associated Press notes, Yellen has instead emphasized being flexible in order to respond to new economic conditions.

Conveying the message that the Fed is flexible enough to respond to changing conditions while not causing turmoil in financial markets will be a challenging balancing act.

"The whole idea of forward guidance is to project this air of clarity and confidence, and that is not happening," David Jones of DMJ Advisors told the AP. "This is a time when the markets need confidence in the Fed."

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Uncertainty about interest rates isn't a bad thing, says Gerald Cohen, Senior Fellow in Economic Studies at the Brookings Institution.
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2014-37-01
Thursday, 01 May 2014 12:37 PM
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