Daily Archives: January 31, 2012

Last week’s decision by the Federal Reserve to provide a quantitative definition of price stability and the publication of the 17 Federal Open Market Committee members’ expectations of the Fed funds rate over the next few years aims at improving transparency and accountability of the central bank. It also raises several questions.

The first relates to the time horizon over which the Fed is supposed to achieve price stability, namely the long-run. This differs from most other central banks in advanced economies, where price stability is targeted over a horizon of two to three years. The reason for focusing on the medium term is that inflation forecasts over a longer period are not very reliable. Price movements 10 years from now will depend on factors that cannot be foreseen today and in any case are hardly affected by today’s policy decisions.

Monetary policy produces its effects with lags of one to three years. This is the period over which the central bank should be held accountable. Focusing over this time horizon also helps market participants. For instance, it’s not too difficult to anticipate a monetary policy tightening if a central bank publishes forecasts that show inflation rising above the stated objective for the next two to three years.

But if the objective of price stability is defined over the longer term, communication becomes more complex. In particular, the link between the inflation forecasts and the policy decision is unclear. What should market participants derive from a published inflation forecast above the two per cent target in the long run (but not necessarily over the next two years)? Should they expect a tightening to take place? And when? The long run is not a “policy-relevant” time horizon and thus has little value for those attempting to understand the central bank’s next moves.

The second question relates to the fact that the interest rate expectations formulated by the FOMC members are all conditional on the state of the US economy. If conditions change over time, the members will revise their forecasts at the next meeting. But for the market to understand this process, and to be able to continiously update its views, it needs to have some idea of the forecasting model used by each of the members. Without this, the task of Fed-watchers will become much more complicated. The suspicion may arise that the interest rate forecasts are ultimately dictated by the members’ short- term policy preferences, rather by than their ability to predict prices over the long-term.

Finally, while the concept of a conditional interest rate forecast is understood by market participants, it may not be by the public and politicians. This could lead to misunderstandings and recriminations. How will people react if, after having taken a decision (for example, take up a mortgage for a new house) on the basis of the Fed’s published expectation of unchanged interest rates until 2014, they find out that interest rates might rise earlier because the conditions underlying the central bank’s forecast have changed. Won’t they, and their elected representatives, blame the Fed for having induced them to take decisions that turned out to be more costly than expected? How easy would it be for the Fed to explain that the earlier interest rate forecast was conditional on assumptions that did not materialise and that people should have taken the forecast with more caution?

To be effective, central bank communication needs to be well understood not only by sophisticated market participants but also by the public. As they are currently designed, the new tools might turn out to be too complex, and risk creating confusion, for both groups. This could be exploited by those, in particular in Congress, who are looking for new excuses to undermine the independence of the Fed. This risk should not be underestimated.

The writer is a former member of the executive board of the European Central Bank and currently visiting scholar at Harvard’s Weatherhead Centre for International Affairs

Diplomats should have permanent cricks in their necks because most international crises are managed through the lens of the last one roughly like it. So the failure of the international community to stand up to the genocide in Rwanda was heavily influenced by the humiliation and fatalities an American UN force had suffered in Somalia that made Bill Clinton wary of intervention in distant African conflicts. Today, Syria is seen through the rear view mirror of Libya.

On the one side, Russia and China speak for those who worry that UN Security Council permission for a humanitarian intervention will be used as a licence for naked support for regime change, which is what they consider happened in Libya. On the other, the UK, France and the US are equally wary of what they see as the success of the Libyan operation not becoming a precedent for serial intervention in the political upheavals of the Arab spring. So, they too are resolute bystanders, even if they wish to see much tougher words, if not actions, from the Security Council condemning the actions of the Assad regime.

That has left the Arab League carrying, or rather, fumbling the ball. Its observer mission is now, however, stalled and the ball has been passed by Qatar, the current Arab League chair, to the UN. A hospital pass if ever there was one.

There is an urgent need for a strategy in New York that promotes President Bashar al-Assad’s early departure and a transition, perhaps via his vice-president, to a broader government and from there to elections. At the same time, there needs to be unified international pressure on the regime to stop the killing and for both sides to respect a monitored ceasefire. Now that the fighting has reached Damascus, this is becoming even more urgent. This is all broadly consistent with the Arab League’s own plan.

There is also a need for an organised system of humanitarian temporary sanctuaries for civilians fleeing the fighting. Turkey and Iraq remain the most likely destinations of any such exoduses and they should be supported in providing this haven just as the Syrian authorities need to be pressed to allow safe exit.

Establishing humanitarian protection and a plan for political transition, without the big stick of threatened military action to back it, might seem a tall order for a divided Security Council. Yet it is better than the hollow threat of intervention that offers a domestic propaganda coup for the Assad regime, which is adept at playing on nationalist conspiracy theories. If intervention is to come it will need to be a Muslim-led UN effort to protect lives with minimal advance notice because even this will rally the regime’s supporters. While there might be a supporting role for Nato logistics in such an operation, the Iraq experience has made actual western troops on the ground a non-starter. A broken Syria would be as hard for the west to put together again as Iraq was and without any of the allegedly compelling rationale to even try.

However, if the two major dynamics of the Syrian crisis are respected, there could still be a happy conclusion. The first is that Syria’s religious complexity, where a small Alawite minority has been reluctantly trusted by other minorities as well the Damascus urban middle class, to hold in check a Sunni majority that comprises three quarters of the population, needs to be factored into a solution. For these minorities, like for Copts in Egypt, an unpleasant regime at least offered stability and security. Promising an orderly transition that stems rising violence through dialogue and offers long-term protection of minority rights needs to be the key platform for the opposition. Then the Syrian National Council, the main umbrella opposition, becomes the guarantor of that critical social glue of stability and security and a violent regime’s enemy.

For the Security Council itself the second narrative is reflected in lessons not from Libya but from Iraq and Afghanistan. Holding together these complex and fragile countries was made much more complicated by the US and its allies initially ignoring the neighbours who had their own interests and clients inside both countries. Excluded from the peacemaking process, countries such as Iran and Pakistan became disruptive forces for fragmentation and partition, rather than finding common cause in maintaining stable neighbours.

This time the Arab League has led – even if imperfectly. Qatar, Saudi Arabia and Egypt have been the key architects. Impatient western members of the Security Council need to go on working with them because these countries, together with Syrians themselves, hold the key to ensuring that chaos does not follow change.

The writer is former UN deputy secretary-general and UK minister of state. He is chairman of global affairs at FTI Consulting and author of ‘The Unfinished Global Revolution’

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