Fed Opens Up on Interest Rate, Inflation Predictions
Danielle Kurtzleben

New 'transparent' communication policy sparks debate, but delivers same bad news

Call it meta-policymaking. The Federal Reserve won't be changing interest rates anytime soon, but it is changing its policy on how it talks about its interest rate policy.

For the first time ever, the Federal Open Market Committee revealed specifics on when individual committee members believe interest rates will again be hiked, bringing the federal funds rate up from its current near-zero level. The committee also released a consensus statement citing 2 percent as its "longer-run goal for inflation," and 5.2 to 6.0 percent as its estimated long-run normal rate of unemployment.

The committee decided that current conditions warrant keeping the federal funds rate at its current near-zero level "at least through late 2014." In its previous statement in November, the committee had anticipated maintaining that level "at least through mid-2013."

As it turns out, not everyone was in agreement. A plurality of voting members, five, voted to frame the near-zero interest rate policy as lasting through 2014, but the other seven chose a range of years, from 2012 through 2016.

At a press conference after the meeting, Federal Reserve Chairman Ben Bernanke explained the virtues of the new communication strategy, saying it will "increase transparency and predictability of policy."

He added that increased transparency can facilitate household and business decision-making, "reduce economic and financial uncertainty, increase effectiveness of monetary policy, and enhance accountability to the public."

Bernanke also stressed that the committee's statement does not mean that the Fed's policymaking procedure has changed, and that the new assessments "should not be viewed as unconditional pledges" and are "subject to future revision."

Not everyone is convinced that the new window onto Fed sausage-making is going to be helpful. Vincent Reinhart, chief U.S. economist at Morgan Stanley and former director of the Fed's Division of Monetary Affairs, wrote in a commentary this week that the new communication policy makes for a "more flexible but weaker" method of signaling policy moves, revealing dissent within the committee.

"To the extent that the new presentation draws attention to minority views, that commitment value will be weakened even more," he wrote.

The ultimate effect could be less public confidence in the Fed, as well as what might happen to the economy, says Brad Sorenson, director of market and sector analysis at Charles Schwab. "We're concerned that overcommunicating to a general public that doesn't follow this on a minute by minute basis can be a little disconcerting that people they view as experts don't really agree on the best course, what the future may hold," he says.

Bernanke, however, pushed back against such criticisms at the press conference, noting that individual committee members have long had the opportunity to make their opinions public. "All of us give speeches. All of us give interviews, and, you know, I give frequent testimony," said Bernanke. "So there's plenty of opportunities to get a sense of what individual members believe."

The decision to maintain low interest rates through 2014 could boost growth, but may not have its intended effect. "In theory, lower interest rates can boost mortgage refinancing, lift equity prices, and increase business investment while supporting vehicle and home sales," wrote Ryan Sweet, senior economist for Moody's Analytics, in an commentary on the Fed decision. But he also noted that interest rates are already at rock-bottom levels, and that maintaining those rates does not alter Moody's GDP expectations.

In addition to changing its interest rate forecast, the Fed also pulled back on its GDP projections. Growth in 2012 is now expected to be between 2.2 and 2.7 percent, down from November's 2.5 to 2.9 percent forecast.

Over the past decade, Fed GDP forecasts have tended to be overly optimistic, as a strategy memo from financial services firm KBW pointed out in a memo this week. If that trend continues, it indicated, it could mean lower interest rates for even longer than the Fed currently predicts: "[The trend of overestimating GDP] suggests that when interest rate forecasts are released, they are likely to present future rate increases earlier than they will actually occur, assuming the forecasting error is maintained."

 

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Fed Opens Up on Interest Rate, Inflation Predictions | Politics

 

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