Interest rate policy

Communicating Monetary Policy Uncertainty

When it comes to forecasting, we usually cite famous Yankee catcher and baseball philosopher Yogi Berra, who reputedly said: “It's tough to make predictions, especially about the future.”

For central bankers, this is more than just a minor headache. Given the lags between policy actions and their effects, forecasting is unavoidable. That puts uncertainty about the economic outlook at the heart of the policymakers’ daily job. Indeed, no one knows the future path of the economy or interest rates—not even those making the decisions.

Communicating this inevitable monetary policy uncertainty is difficult, but essential. In the United States, the Federal Open Market Committee (FOMC) uses a variety of means for this purpose. In two earlier posts, we discussed the evolution of FOMC communications and the usefulness of the quarterly survey of economic projections (SEP). Here, we examine a key aspect of FOMC communications that receives insufficient attention: the explicit publication of policymakers’ range of uncertainty about the future path for the policy rate. Buried near the end of the FOMC minutes, published three weeks after the SEP release, this information is consumed only by die-hard devotees….

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FOMC Communication: What a Long, Strange Trip It's Been

Following their January 2019 meeting, the Federal Open Market Committee (FOMC) came in for intense criticism. Instead of a truculent President complaining about tightening, this time it was financial market participants grumbling about a sudden accommodative shift. In December 2018, Fed policymakers’ suggested that, if the economy and market conditions evolved as expected, they probably would raise interest rates further in 2019. Faced with changes in the outlook, six weeks later they altered the message, suggesting that going forward, monetary easing and tightening were almost equally likely.

We find the resulting outcry difficult to fathom. The FOMC’s perceptions of the outlook may have been incorrect in December, in January, or both. There are myriad ways for economic and market forecasts to go wrong. But, to secure their long-run objectives of stable prices and maximum sustainable employment, isn’t it sometimes necessary for policymakers to change direction, and when they do, to explain why?

The point is that the recent turmoil arises at least in part from the Fed’s high level of transparency. In this post, we summarize the evolution of Federal Reserve communication policy over the past 30 years, and discuss the importance and likely impact of these changes. While transparency is far from a panacea, we conclude that the evolution has been useful for making policy more effective and sustainable, and remains critical for accountability and democratic legitimacy….

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Monetary Policy and Financial Stability

In June 2015, a committee of Federal Reserve Bank Presidents conducted a “macroprudential tabletop exercise”—a kind of wargame—to determine what tools to use should risks to financial stability arise in an environment when growth and inflation are stable. The conventional wisdom—widely supported in policy pronouncements and in a range of academic studies—is that the appropriate tools are prudential (capital and liquidity requirements, stress tests, margin requirements, supervisory guidance and the like). Yet, in the exercise, the policymakers found these tools more unwieldy and less effective than anticipated. As a result, “monetary policy came more quickly to the fore as a financial stability tool than might have been thought.”

This naturally leads us to ask whether there are circumstances when central bankers should employ monetary policy tools to address financial stability concerns. Making the case for or against use of monetary policy to secure financial stability is usually based on assessing the costs and benefits of a policy that "leans against the wind" (LAW) of financial imbalances...

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