The Fed's New Forecasts Mean Big, Unappreciated, Changes
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By ROBERT EISENBEIS ; November 16, 2007 12:37 p.m.
The FOMC has announced significant changes in its communications policy. Namely, it will expand its semi-annual release of FOMC member forecasts to quarterly, lengthen the time horizon covered to three years from two years, expand the number of variables covered and provide detailed narrative discussions of the risks. The indication is that individual forecasts, or at least the central tendency will continue to be made available along with the range of forecasts for each year. In addition, comparison information with previous forecasts will be offered, the distribution of the forecasts for each variable and how the distributions have changed over time.
Besides providing a clearer window into FOMC deliberations, the new process will have significant implications, not yet widely appreciated, for the structure FOMC deliberations and how the Board members and reserve banks manage their approach to FOMC preparation. First, the focus on forecasts will deepen and improve the quality of the debate at the FOMC. In particular, discussion will focus more on detailed discussion and comparisons of the independent forecasts of FOMC participants and should shift away from providing anecdotal information about local developments.
Second, several of the reserve banks will have to up their research and emphasis on forecast modeling. Some banks presently rely heavily upon the forecasts contained in the Greenbook and/or outside forecasts without the benefit of a rigorous and independent in-house forecasting program.
Third, the items being forecast send a clear signal as to what the FOMC is concentrating on in terms of key macro variables, such as core and overall PCE inflation. Interestingly, nominal GDP forecasts won't be provided.
Fourth, the new procedures will pose an interesting problem for the Board of Governors FOMC members who don't have their own independent forecasting staffs to draw upon like the reserve bank presidents in preparing their forecasts. This means that the governors' forecasts will be heavily weighted toward, and influenced by, the Board staff forecast, and these will be combined with the independent forecasts of the reserve bank presidents.
Fifth, the release of the minutes with the forecasts will become the more significant event than the announcement of the actual FOMC decision. Interestingly, there will be a disconnect between market reactions to the quarterly meetings, which do provide the forecasts from those meetings where the forecasts are not available. Additionally, speeches by FOMC participants will be more closely scrutinized following meetings where forecasts were provided until the minutes are released than speeches following meetings where no forecasts are released. One can conjecture that participants will gravitate towards providing their detailed forecasts for each meeting and one of two things will happen. Either significant policy moves will only be made quarterly and accompanied with the new forecasts, or the Committee will quickly conclude that it will have to provide its forecasts following each meeting.
Sixth, the new procedures will complicate the communications issue when policy moves are dictated by risk management considerations as distinct from those rooted in pure forecasts. Risk management policy justifications will look inconsistent with model forecasts and will require much more detailed elaboration, especially when policies are reversed because actions induced by risk management considerations are no longer needed.
Of course the ultimately usefulness of the increased disclosures will lie in the details of what is provided. For example, providing the full set of forecasts, without truncation of the extremes would be much more meaningful than simply the central tendency and range. It would be interesting to see the sets of forecast variable projections for each member. This would allow outside observers to assess the internal consistency of the individual forecasts. After all, members are preparing joint forecasts of the key variables. Finally, the Committee has finessed the issue of what the policy path assumptions are over the three year time horizon of the forecasts by simply saying that "... projections will be made under the assumption of 'appropriate' monetary policy." A better approach would be to assume the path for the policy rate contained in the Fed Funds futures market. After all, this is all that market participants can observe and it is what their decisions are based upon.
For investors, this release of information will heighten their interest in FOMC releases and the minutes should prove to be significant market events. Whether the information will improve the market's understanding of the policy process or serve to better anchor market inflation expectations is yet to be determined. While this may be a good first step, the change is clearly only a chapter in the book and we are not close to understanding how the story will end.
Mr. Eisenbeis is the former research director at the Federal Reserve Bank of Atlanta. |
