What is a 'Moral Suasion'

Moral suasion is the act of persuading a person or group to act in a certain way through rhetorical appeals, persuasion or implicit threats, as opposed to the use of outright coercion or force; it is commonly used in reference to central banks.

BREAKING DOWN 'Moral Suasion'

Anyone can in principle use moral suasion to try to convince another party to change their attitude or behavior, but in an economic context it generally refers to central bankers' use of persuasive tactics in public or private. It is often simply called "suasion": the motives behind it are not always altruistic, but have more to do with the pursuit of particular policies. In the U.S., it is also known as "jawboning," since it amounts to talk, in contrast to more forceful methods the Federal Reserve and other policymakers have at their disposal.

More specifically, attempts by central banks to influence the rate of inflation without resorting to open market operations are sometimes called "open mouth operations."

Long-Term Capital Management

A famous example of the use of moral suasion is the New York Federal Reserve's intervention in the bailout of Long-Term Capital Management (LTCM) in 1998. LTCM was a highly successful hedge fund, generating a string of high-double-digit annual returns in the 1990s. It was highly leveraged, however, with around $30 of debt per dollar of capital at the end of 1997. The Asian financial crisis sent it into a tailspin, leading to worries that a fire sale of its assets would drive down prices and leave its creditors – the bulk of Wall Street's major banks – with massive unpaid loans on their books.

Rather than directly injecting public money, the New York Fed called a meeting in its offices of three banks that had lent to LTCM. These banks decided to cooperate on a rescue, which the Fed helped coordinate but did not fund. Eventually a consortium of 14 banks bailed LTCM out for $3.6 billion. The fund was liquidated two years later and the banks earned a slight profit. The New York Fed was criticized for creating the impression that LTCM was "too big to fail," but the decision to pressure banks into providing bailout funds was seen as an alternative to more heavy-handed – and potentially harmful – tactics, rather than to doing nothing.

Fedspeak

Moral suasion can be employed in public as well as behind closed doors. Fed chair Alan Greenspan's criticism of the prevailing economic mood as "irrational exuberance" in 1996 is remembered as a classic example of the Fed's use of suasion, but when asset prices did collapse in 2000, critics attacked Greenspan for having done too little – be it with interest rates, margin lending requirements or jawboning – to check the 1990s' exuberance.

In recent years the Fed has made a concerted effort to engage more with the public, which could be seen as an effort to increase transparency – or to leverage its power of moral suasion. Greenspan advocated a policy of "constructive ambiguity" – arguably the opposite of moral suasion – famously telling a senator, "if you understood what I said, I must have misspoke." Ben Bernanke broke with that approach and made an effort to communicate Fed policy more clearly; he introduced press conferences in 2011 at the suggestion of his eventual successor, Janet Yellen.

Increased jawboning may have been seen as necessary, given the decreased ability of the Fed to cut interest rates – which were near zero from December 2008 to December 2015 – or increase the size of its balance sheet much further. With traditional monetary policy tools more difficult to employ, the Fed has attempted to convince markets of its willingness to support a sustained economic recovery through words rather than deeds, when possible.

These tactics are not limited to the U.S. In 2012 European Central Bank president Mario Draghi said the bank would do "whatever it takes" to preserve the euro. 

RELATED TERMS
  1. Long-Term Capital Management (LTCM)

    Long-Term Capital Management (LTCM) was a large hedge fund led ...
  2. Moral Hazard

    Moral hazard is the risk that a party to a transaction has not ...
  3. Central Bank

    The entity responsible for overseeing the monetary system for ...
  4. Fed Funds Futures

    Fed funds futures are contracts that reflect market predictions ...
  5. Risk-Based Deposit Insurance

    Risk-based deposit insurance includes premiums that reflect how ...
  6. Federal Reserve System - FRS

    The Federal Reserve System, commonly known as the Fed, is the ...
Related Articles
  1. Insights

    How Much Influence Does The Fed Have?

    Find out how current financial policies may affect your portfolio's future returns.
  2. Insights

    Janet Yellen Vs. Alan Greenspan: Who Is The Better Fed Head?

    We examine how these two histories Fed chairpeople differ and the impact of their views and actions on the world economy.
  3. Insights

    'Irrational Exuberance' 20 Years On

    The S&P is up 196% since Greenspan uttered these now-famous words.
  4. Small Business

    Moral Hazards: A Bump In The Contract Road

    Learn how this phenomenon can cause a party in an agreement to behave differently than expected.
  5. Insights

    7 Misconceptions About The Federal Reserve

    There are many fallacies about the Fed. The following misconceptions are among the most popular.
  6. Insights

    Alan Greenspan: 19 Years In The Federal Reserve

    Follow the economic glories and bumbles in the career of the previous Fed chair.
  7. Insights

    Should Central Banks Be Independent?

    Find out why more and more experts are calling for an end to central bank independence, any why such provocative calls may be just as dangerous.
RELATED FAQS
  1. What is moral hazard?

    Understand that moral hazard is the idea that a party protected in some way from risk will act differently than if they didn't ... Read Answer >>
  2. What is the difference between moral hazard and morale hazard?

    Insurance industry terms, morale hazard and moral hazard - know the difference. Read this article on Investopedia. Read Answer >>
  3. What is the difference between a principle agent problem and moral hazard?

    Learn how a principal-agent problem often leads to moral hazards in the context of an agent and principal having different ... Read Answer >>
  4. Should commercial and investment banks be legally separated?

    Find out why market risk isn't created by letting commercial and investment banks merge; it results from moral hazard and ... Read Answer >>
  5. How successful have "dove" Federal Reserve heads been in the past when it comes to ...

    Review a short history of "dovish" leaders of the Federal Reserve, who use U.S. monetary policy to reduce unemployment through ... Read Answer >>
Hot Definitions
  1. Diversification

    Diversification is the strategy of investing in a variety of securities in order to lower the risk involved with putting ...
  2. Intrinsic Value

    Intrinsic value is the perceived or calculated value of a company, including tangible and intangible factors, and may differ ...
  3. Current Assets

    Current assets is a balance sheet item that represents the value of all assets that can reasonably expected to be converted ...
  4. Volatility

    Volatility measures how much the price of a security, derivative, or index fluctuates.
  5. Money Market

    The money market is a segment of the financial market in which financial instruments with high liquidity and very short maturities ...
  6. Cost of Debt

    Cost of debt is the effective rate that a company pays on its current debt as part of its capital structure.
Trading Center