Bernankeology

Why so much is read into the words of the Fed chairman.

Following Fed chairman Ben Bernanke's speech yesterday, the usual bout of trying to understand quite how much we can read in to his words has begun. Yet unlike the normally perjorative "Kremlinology" – attempting to infer things from the most minuscule turns of phrase – this Bernankeology is understandable and quite useful.

Central bankers have a strange job. They don't actually have many tools at their disposal; largely just the tripartite decision to raise, lower, or maintain interest rates. Yet many of the outcomes they create come, not from actually using this power, but from creating expectations as to their future use.

Suppose Bernanke knows he is likely to raise interest rates in the first quarter of 2013. Even though his actual power is relatively limited, he can create a wide spectrum of outcomes depending on how he announces this. The market reaction will be extremely different if Bernanke says now that he will raise rates in a years time, compared to if he maintains right up until the day that a rate rise would be inappropriate.

But this power to persuade brings with it its own problems. Just like a legislature, a central bank is fundamentally unable to constrain itself; it can make promises, but everyone knows that it is free to break them at any point.

All of this means that every speech Bernanke gives is likely to be very carefully aimed at creating just the right set of expectations. On the one hand, he can't ever gain a reputation for untrustworthiness, so they have to be scrupulously honest; on the other, actually saying what he believes may create the wrong impression.

Last week, Ryan Avent provided a detailed breakdown of exactly what the benefits of Bernankeology can be, focusing on the Fed's "forward guidance" where it hinted that it would keep interest rates low until at least 2013. He writes:

On the one hand, a pure focus on the language of the Fed's statement indicates that rates are likely to remain low through that period based on the state of the economy... On the other hand, the Fed may be hinting that it will be willing to keep rates low through late 2014 even if the trajectory of the economy warrants a rate increase.

In other words, the Fed might be attempting to commit itself to a deviation from its normal policy rules of the sort that might generate more rapid growth and inflation.

The problem the Fed has is that it needs to generate growth, but that growth is likely to come with relatively high inflation, of the sort which Bernanke has historically fought against. In order to help the economy, he needs to convince "the markets" that interest rates will be kept low even if inflation spirals out of control. The problem is that this, from an inflationary hawk like Bernanke, is unbelievable.

Avent points to a paper (pdf) which breaks down the distinction into two categories:

Delphic, corresponding to the first category above, and Odyssean, corresponding to the second, in which the central bank attempts to commit itself to deviations from typical rules.

Matt Yglesias offers a less refined version of the same strategy, breaking Bernanke's possible responses into an Eeyore response and a Tigger one. Either the Fed chief can "avoid optimistic forecasts as a way of signaling that rates will stay low for a long time," or he "can say we're climbing out of a steep hole so rates will stay low for the next 18 months come what may".

The test for Bernankeologists is to work out whether yesterday's gloomy speech is Odyssean-Eeyore, using gloominess as a mast to bind himself to, or simply Delphic, with the chairman making his most honest predictions and still being pessimistic.

Occupy LA activists march against the Fed in November. Credit: Getty

Alex Hern is a technology reporter for the Guardian. He was formerly staff writer at the New Statesman. You should follow Alex on Twitter.

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Tom Watson rouses Labour's conference as he comes out fighting

The party's deputy leader exhilarated delegates with his paean to the Blair and Brown years. 

Tom Watson is down but not out. After Jeremy Corbyn's second landslide victory, and weeks of threats against his position, Labour's deputy leader could have played it safe. Instead, he came out fighting. 

With Corbyn seated directly behind him, he declared: "I don't know why we've been focusing on what was wrong with the Blair and Brown governments for the last six years. But trashing our record is not the way to enhance our brand. We won't win elections like that! And we need to win elections!" As Watson won a standing ovation from the hall and the platform, the Labour leader remained motionless. When a heckler interjected, Watson riposted: "Jeremy, I don't think she got the unity memo." Labour delegates, many of whom hail from the pre-Corbyn era, lapped it up.

Though he warned against another challenge to the leader ("we can't afford to keep doing this"), he offered a starkly different account of the party's past and its future. He reaffirmed Labour's commitment to Nato ("a socialist construct"), with Corbyn left isolated as the platform applauded. The only reference to the leader came when Watson recalled his recent PMQs victory over grammar schools. There were dissenting voices (Watson was heckled as he praised Sadiq Khan for winning an election: "Just like Jeremy Corbyn!"). But one would never have guessed that this was the party which had just re-elected Corbyn. 

There was much more to Watson's speech than this: a fine comic riff on "Saturday's result" (Ed Balls on Strictly), a spirited attack on Theresa May's "ducking and diving; humming and hahing" and a cerebral account of the automation revolution. But it was his paean to Labour history that roused the conference as no other speaker has. 

The party's deputy channelled the spirit of both Hugh Gaitskell ("fight, and fight, and fight again to save the party we love") and his mentor Gordon Brown (emulating his trademark rollcall of New Labour achivements). With his voice cracking, Watson recalled when "from the sunny uplands of increasing prosperity social democratic government started to feel normal to the people of Britain". For Labour, a party that has never been further from power in recent decades, that truly was another age. But for a brief moment, Watson's tubthumper allowed Corbyn's vanquished opponents to relive it. 

George Eaton is political editor of the New Statesman.