In an opinion column in the Wall Street Journal, economist Sebastian Mallaby argued that when investors believe that financial markets will remain calm, they may be more willing to make risky investments. The result can be a financial crisis such as occurred during 2007–2009, when the prices of risky mortgage-backed securities declined.
Mallaby argued:
The central-banking fashion now is to target inflation and to communicate prodigiously about coming interest-rate adjustments….But stable finance often matters more than stable prices. And transparency about future interest-rate moves can induce disruptive speculation.
a. What does the Fed call attempts to shape expectations of future policy decisions?
b. Why did targeting inflation and communicating about future changes in interest rates become “central bank fashion”?
c. Why might investors be more likely to buy risky securities if they feel confident that they know what interest rates will be in the future as a result of Fed announcements?