A post by Kim Schoenholtz
Last week the Fed released – for only the second time – individual members’ projections of the target federal funds rate. The median projection for late-2014 is now at 1% — about 25 basis points higher than in the original January projections. Moreover, only four of 17 FOMC members now expect that the first rate hike will occur after 2014, down from the previous tally of six.
In contrast, the Fed’s policy statement was largely unchanged in April. By a 9 to 1 majority, the Federal Open Market Committee still anticipates that economic conditions “are likely to warrant exceptionally low levels of the federal funds rate at least through 2014.” The FOMC also continued balance sheet policies intended to provide additional monetary stimulus in an environment where the target interest rate – already near zero – cannot be reduced further.
So when does the Fed expect rates to rise: sooner, as the members’ projections suggest, or later, as the policy statement indicates? All this transparency is a wonderful thing, but what’s the real message here?
Responding to several related questions at last week’s press conference, Chairman Bernanke described the individual projections as “inputs” to the process from which the policy statement arises. He indicated that FOMC members expressed uncertainty about their projections. He also noted that the meeting discussion included risks to the outlook (eg, whether the unemployment rate will continue to fall despite modest economic growth; the situation in Europe; the prospective “cliff” in US fiscal policy). Finally, he pointed out that the use of vague language facilitates consensus because “participants in the FOMC might have somewhat different views of what exceptionally low means.”
So where does that leave the Fed’s project of promoting greater transparency?
Still a bit muddy, it seems to me. Describing the interest rate projections as Committee inputs downplays their importance. Highlighting alternative economic scenarios turns attention to the entire distribution of outcomes – not just central forecasts – and especially to costly tail risks that cannot be addressed by conventional monetary policy at the zero bound. Using vague language to achieve consensus may help the Committee function, but does little to help observers anticipate its future behavior and, thereby, make policy more effective.
The bottom line is that the Fed’s communications strategy remains a work in progress. In the words of the Chairman: “the Committee … [has] been working to try to provide more explicit guidance, quantitative guidance about our policy reaction function, but so far, you know, we really haven’t done that.”
The FOMC will have to get used to the stringencies of increased transparency, if its message is to be clear and consistent. Fortunately, as the Chairman’s press conference highlights, a few experienced Fed-watching journalists are doing their part to promote clarity and expose fragile compromise. If they keep it up, they will help the FOMC make policy more effective.