Fed Openness Poses Risk Rate Forecast to Be Viewed as Vow

Charles Plosser
Charles Plosser, president and chief executive officer of the Federal Reserve Bank of Philadelphia, speaks at the Levy Economics Institute conference in New York, U.S. Photographer: Michael Nagle/Bloomberg

Federal Reserve Bank of Philadelphia President Charles Plosser was answering reporters’ questions two weeks ago when he paused to seek their assistance on the Fed’s campaign to open up to the public.

“Help me out here,” Plosser said after a Jan. 11 speech in Rochester, New York. “There’s a huge confusion about this,” he said, referring to Fed plans to start releasing policy makers’ forecasts for the benchmark interest rate tomorrow.

Plosser said he was concerned investors might misinterpret the projections as a pledge to keep borrowing costs low for a specified period. That could make it harder for the central bank to raise interest rates should the need arise, said Stephen Stanley, chief economist at Pierpont Securities LLC in Stamford, Connecticut.

“It’s not at all clear how people are supposed to react” to the Fed’s new communications policy, Stanley said. “If it does start to take on that sense of being a commitment,” he said, “it runs a great risk in terms of their credibility when they end up not being able to stick to it.”

The Federal Open Market Committee plans to release all 17 policy makers’ rate projections for the fourth quarter of 2012, the next few years and the long run, as well as an explanation for their assessments. The Fed will provide the information at the conclusion of a two-day meeting tomorrow. The FOMC convened today at about 10 a.m.

Views Voiced

The decision to announce the projections is the latest effort by Chairman Ben S. Bernanke to increase openness and public understanding of the Fed. Since becoming chairman in 2006, Bernanke has begun holding regular press conferences and voiced his views in television interviews and at town hall meetings. He’s also announced forecasts on economic growth, unemployment and inflation four times a year, up from twice annually under his predecessor, Alan Greenspan.

Chicago Fed President Charles Evans, who this month reiterated his call for adding more stimulus, said on Jan. 13 that the central bank’s “enhanced communications” mark a “substantial, first-order improvement” over the Fed’s previous efforts. Publishing the projections will help the public better evaluate the committee’s views, while allowing monetary policy to “respond more strongly in the medium-term when adverse economic shocks impede growth and employment,” he said.

Policy makers want to telegraph their expectations for the appropriate path for the overnight lending rate between banks, Plosser said. That shouldn’t be confused as a commitment on the level of interest rates.

‘Policy Views’

“What we’re doing is describing to the public the range of policy views that the committee has,” said Plosser, 63. He dissented twice last year against further accommodation and the Fed’s pledge to hold rates low at least through mid-2013.

The Fed’s record in forecasting has been mixed. Transcripts of its 2006 meetings show the central bank didn’t foresee the housing collapse and financial crisis that began in 2007, or the 18-month recession that followed. A sudden decline or improvement in the outlook for the economy may compel Fed officials to deviate from their projected interest-rate path.

“We’re going to see how difficult it is for the Fed to anticipate movements in key economic variables based on its projections for the fed funds rate,” said Paul Kasriel, chief economist for Northern Trust Corp. in Chicago. The 2006 transcripts show “the Fed was kind of flat-footed” in its outlook for the economy.

Raise Benchmark Rate

Economists predict the Fed will wait until the first quarter of 2014 to raise its target for the federal funds rate to 0.75 percent from near zero, where it’s been since December 2008, based on the median estimate of 32 analysts surveyed by Bloomberg News this month.

“There are risks,” said Dean Maki, chief U.S. economist at Barclays Capital in New York. “The Fed could guide markets to an outcome that turns out to be very different than what actually happens. That could increase volatility.”

The yield on Treasury 10-year notes has climbed to 2.06 percent from a record low of 1.67 percent on Sept. 23 as investors bought riskier assets amid signs finance officials were near an agreement aimed at defusing Europe’s debt crisis. Yields had plunged as investors speculated central banks would have to enact further easing to avert a global recession.

Disclosing the forecasts for the fed funds rate wasn’t intended as an easing measure, though it may inadvertently push expectations for an interest-rate increase further into the future, Plosser said.

“That’s the wrong way of reading this,” he said. “It is about transparency.”

December Meeting

The FOMC decided to reveal the forecasts after “a number of members noted their dissatisfaction with the committee’s current approach,” according to the minutes of their December 2011 meeting. Several members said the commitment to keep interest rates low at least through mid-2013 may need adjustment, the minutes said.

“The actual release of the forecasts will give a lot more information about how the Fed’s viewing the situation,” Maki said. “I do think that is helpful.”

The forecasts are “a better way” of communicating the path of policy than giving a date, and the quarterly release of the projections will give the Fed flexibility to change expectations over rates, Plosser said.

The forecasts free policy makers from the “straitjacket of the mid-2013 pledge,” Stanley said. While the existing commitment “does not lend itself well to discreet changes,” the “quarterly forecasts allow you to take small tweaks.”

Amount of Clarity

Still, the number of individual forecasts by FOMC participants may limit the amount of clarity, St. Louis Fed chief James Bullard, 50, said after a Jan. 13 speech.

“It’s not going to be perfect” because “you still have 17 possible paths” laid out by Fed officials, Bullard said. There is “some risk” investors misconstrue the forecasts as a commitment to a set course for interest rates, he said.

The central banks of Norway and Sweden have published the expected path of interest rates since 2005 and 2007, and did U-turns last year on their rate predictions. Their experience highlights the risks for the Fed, according Robert Bergqvist, chief economist at Stockholm-based SEB AB and former head of research at the Riksbank, Sweden’s central bank.

The Fed’s newest move on communications may not prove “beneficial” to the U.S. economy or financial-market stability, Bergqvist said. “The risk is high that volatility in financial markets will increase,” and “the central bank can give false certainty” to households, investors and businesses, he said.

Tjorvi Olafsson, an economist at the Central Bank of Iceland since 2005, said his research indicates investors can adapt to sudden deviations in a central bank’s expected interest-rate path.

“Experience from other countries indicates that the risk associated with misinterpretations of this type of projections should be manageable,” he said in an e-mail reply to questions.


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