Fed may start publishing forecasts of own policy path

Genevieve Signoret & Patrick Signoret

The NYT reports that the Fed may start to publish forecasts of its own policies. This would may give the central bank more leverage over  market expectations. With the USA in a liquidity trap, the Fed is keen to keep real interest rates low or (preferably) negative. To do so, it needs to keep expected inflation rates positive. They’re hoping that this is a low-risk way to do so. The NYT explains it well:

WASHINGTON — The Federal Reserve’s decision three years ago to reduce short-term interest rates to nearly zero made a splash, both because the Fed had never pushed rates so low and because it said that it planned to keep rates near zero “for some time.”

Ben S. Bernanke, the Fed’s chairman, and other officials say that improved communications could deliver a modest boost to the economy with relatively little risk.

Predicting its own future actions was a new step, an experiment in a time of crisis that the Fed has since repeated several times, most recently in August, when it said that it planned to keep interest rates near zero until at least the summer of 2013.

Now the technique looks increasingly likely to become a permanent method for influencing economic growth. When the Fed’s policy-making committee convenes on Tuesday, it will consider the idea of publishing a regular forecast of its future decisions on interest rates. Any such plan would most likely be announced no sooner than its next meeting, in January, when it is already scheduled to publish economic projections.

Forecasting policy is part of a broader set of changes that the Fed is considering to improve public understanding of its methods and goals. The Fed’s chairman, Ben S. Bernanke, and other officials say that improved communications could deliver a modest boost to the economy with relatively little risk. None of their other options for additional action are nearly so appealing.

“We are actively considering methods that we could use to provide greater clarity,” Janet L. Yellen, the Fed’s vice chairwoman, said after a recent speech in San Francisco. “Is it a game-changer? I feel that it could have some favorable impact. I don’t want to exaggerate how large that is.”

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Monetary economists had long agreed that central banks should avoid making predictions or commitments. They worried that deviations from the predicted path would create costly turbulence in financial markets as investors corrected their misconceptions.

In recent years, however, more policy makers have concluded that the power to shape expectations should be embraced. Some central banks have come to regard speaking about the future as a primary policy tool. For example, the central banks of Britain, Canada and Australia, among others, have adopted explicit goals for inflation and the rate of increase in prices and wages. The central banks of Sweden and Norway publish forecasts of the level of interest rates. New Zealand announces goals and forecasts.

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The minutes of the committee’s most recent meeting, in November, said that “participants generally expressed interest in providing additional information to the public about the likely future path of the target federal funds rate.”

Such a forecast likely would cover the expected path of policy over the next three years, including information about the range of predictions. The Fed already publishes similar predictions about economic growth, inflation and unemployment four times a year.

Introducing a forecast in the near future could reduce borrowing costs for businesses and consumers if it shows that the committee expects rates to remain near zero beyond mid-2013. Investors demand compensation for long-term investments based in large part on their expectations about the future level of short-term rates

Even some members of the committee who oppose additional stimulus, however, want to start publishing the forecast. Charles I. Plosser, president of the Federal Reserve Bank of Philadelphia, who has voted repeatedly against expansion of the Fed’s aid programs, said he favored the proposal irrespective of whether the immediate effect was to stimulate the economy.

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Some analysts, however, warn that increased clarity could have negative consequences.

“My concern is that the Fed might place itself in a self-induced bind” if it predicts a policy path that later seems unwise, said Dana Saporta, a United States economist at Credit Suisse. “They would feel some pressure to stick to the implicit promise in the forward guidance, lest they incur the wrath of the markets and Congress.”

Ms. Saporta also noted that the 2007 decision to publish economic projections had focused some unflattering attention on the Fed’s inability to predict the future.

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