During its last meeting of the year the Federal Reserve, via its interest rate-setting Open Market Committee, decided that it will start publishing forecasts of — wait for it — interest rates. That’s right, the FOMC is going to publish its own predictions for the very thing over which it has sole responsibility. What gives?
Measures to ”enhance the clarity and transparency of [the Fed's] public communications” have been a pet project of Ben Bernanke for some time. It kicked off when he decided last year to start holding news conferences following each FOMC meeting. It may not sound like much but in the annals of central banking that’s a bit like the Queen of England agreeing to be interviewed by Wendy Williams. But the way the Fed is implementing this latest change is quite peculiar.
Here’s how the FOMC normally works. By law it must meet at least 4 times a year. Before it meets each member is briefed on economic conditions and given a thick stack of documents showing what the Fed’s staff economists are forecasting, what options they’ll have to vote on and what conditions are like in the districts of each regional Reserve Bank. At the meeting they discuss all of this info, someone reads a summary of the options and then the 12 voting members of the FOMC vote. A simple majority wins. When the meeting minutes are published 6 weeks later you can see who voted for and against, plus all of the other discussion that took place.
So while there may not be consensus on the action (and lately there’s been a bit more dissent among the voting members than in the past), at the end of the day it’s still just one action taken or not taken, whether they all agree or not. That, right there, is clarity.
With these new forecasts, however, each member will be asked to give a number for what they think the interest rate will be at the end of this year, the end of next few years and also in the long run. Note: the members already provide quarterly forecasts for what they think economic growth, unemployment and inflation will be. The new plan will ask them to add interest rates to this mix. But obviously, the first three are not things on which they exert sole and direct influence. While interest rates most emphatically are. Won’t it be confusing to have 12 different predictions for this?
Some of the FOMC members, themselves, certainly thought so. From the December minutes:
One participant suggested that the economic projections would be more understandable if they were based on a common interest rate path. Another suggested that it would be preferable to publish a consensus policy projection of the entire Committee. Some participants expressed concern that publishing information about participants’ individual policy projections could confuse the public; for example, they saw an appreciable risk that the public could mistakenly interpret participants’ projections of the target federal funds rate as signaling the Committee’s intention to follow a specific policy path rather than as indicating members’ conditional projections for the federal funds rate given their expectations regarding future economic developments. [...] Some participants did not see providing policy projections as a useful step at this time.
And yet at the end of the day the decision was made to go ahead with it. How, exactly, is not quite clear: the minutes do not mention a vote being taken on this one. Peculiar, indeed. Especially since the minutes tell us that the proposal for these forecasts came from the Fed’s staff subcommittee for communications. They were given the task to research how the Fed could improve its communication, also when benchmarked against other central banks, and this is what they came back with. How could they have missed Alan Blinder’s piece on this very topic? In which Blinder, et al. say (emphasis mine):
[T]he predictability of monetary policy appears to be degraded somewhat when central banks speak with too many conflicting voices, or what is referred to as a “cacophony problem” (Blinder 2004, Chapter 2). When monetary policy decisions are taken and subsequently explained by a committee rather than by a single individual, there is a danger that too many disparate voices might confuse rather than enlighten the public – especially if messages appear to conflict. If done poorly, uncoordinated group communication might actually lower, rather than raise, the signal-to-noise ratio. But the appropriate remedy for this problem, should it exist, is clarity, not silence.
This paper’s from 2008. It’s been cited in numerous places, for instance in the Economist and Naked Capitalism. It took me all of 10 minutes to find it. So why didn’t they? And in the absence of that, why didn’t Ben listen to the FOMC members with common sense who told him that this idea is bananas? It certainly seems like the Fed is more concerned with giving the appearance of improved clarity and transparency without actually providing any. Which certainly matches its past behavior.
Category: Federal Reserve