Insight Line—March 5, 2007

Not that long ago Federal Reserve Board Vice- Chairman Donald Kohn offered up his comments and observations with respect to public commentary from the nation’s central bankers. “We need to be particularly careful that people understand how limited our knowledge actually is—the uncertainty and conditionality around any statement we make about future developments,” he cautioned.¹

It appears his message got through.

A recently released study by Laurence Meyer (a former member of the FOMC) and Brian Sack of Macroeconomic Advisors LLC ascertained the extent to which comments made by Federal Open Market Committee (FOMC) members and Federal Reserve regional bank presidents affect the markets’ movements. In their analysis, Meyer and Sack conclude that speeches by Federal Reserve officials triggered smaller overall changes in the yield of two-year U.S. Treasury notes in 2006 than in 2005.²

Yet such complacency on the part of investors with respect to central bankers opining, did not happen overnight. It is a relatively new phenomenon that apparently coincides with the advent of Ben S. Bernanke as Chairman of the FOMC. But can investors reasonably draw causation from this correlation?

The secrecy surrounding monetary policy decisions by the FOMC is legendary. For years, investors seeking the FOMC’s intentions found themselves participating in an effort akin to reading tea leaves. That is, until February 1994.

In 1994, in an attempt to explain their decision process, the FOMC began releasing statements accompanying changes in the inter-bank overnight lending rate, more commonly referred to as the federal funds rate. To be sure, the improved communication was, as far as investors were concerned, a step in the right direction. However, sometimes well-meaning intentions have unintended consequences. Almost immediately, the FOMC’s statement achieved notoriety not for what it said, but for what it did not say, thus leaving investors to translate “Fed-speak” for themselves.

Sensing its process of communication created unfounded expectations, the FOMC fine-tuned its protocol once more in May 1999. Since then, concurrent with the conclusion of its regularly scheduled meetings, the committee discloses via a press release a directive containing its views about the balance of risks and the likely near-term course of monetary policy.

But, as I see it, the greatest breakthrough in unveiling the stated intentions of monetary policy did not arrive until the appointment of Ben S. Bernanke to chair the FOMC in February 2006. You see, having served as a member of the FOMC prior to his appointment as Chairman, Dr. Bernanke had delved deeply into the issue of central bank communication. In 2003, he concluded the last bit of clarity lay not in additional public commentary but within the Semi- Annual Monetary Policy Report to Congress.

This report to Congress, he suggested, already communicated a wide range of critical data. Forecasts from the Federal Reserve staff economists on the most likely course for gross domestic product, inflation and employment were well-researched and highly detailed, and left little doubt as to the Fed’s consensus. In fact, he believed that by raising the report’s stature among FOMC members and with a few minimal adjustments to emphasize the relative importance of some areas over others, the report could serve as a biannual forum for the nation’s central bankers to clearly outline their preferred course for monetary policy.

All of which brings us back to Meyer and Sack’s findings on the reduced impact of Fed comments on interest rate volatility. You see, Dr. Bernanke delivered his first Monetary Policy Report to Congress in February 2006 in which he decisively outlined to members of Congress, investors and the investing public the underlying economic and monetary conditions that would be factored into the policy directives in the period ahead.

And if market reaction to his February 2007 Monetary Policy report is to be taken as a guide, I suggest Meyer and Sack may report in early 2008 that FOMC member speeches continued to elicit even less market movement.

Simply put, investors may come to view public commentary by FOMC members as yesterday’s news.

¹ “Central Bank Communication,” Governor Donald L. Kohn, Remarks at the annual meeting of the American Economics Association, Philadelphia, Pennsylvania, Federal Reserve Board of Governors, January 9, 2005.

² “Fed Speeches Had Less Market Influence Last Year,” Vivien Lou Chen, Bloomberg, LP, February 6, 2007.

This material has been prepared using sources of information generally believed to be reliable. No representation can be made as to its accuracy. The forecasts and opinions in this piece are not necessarily those of Van Kampen, and may not actually come to pass. Information in this report does not pertain to any Van Kampen product and is not a solicitation for any product.