Dump The Dots

Members of the Fed’s Open Market Committee must regret having agreed to provide the dot chart estimates of future fed funds rates.  Those charts are doing more harm than good.

The charts stemmed from the Bernanke/Yellen hypothesis that providing more guidance about the rate outlook would make monetary policy more effective.  Hence, the charts showing what each member thinks will be the appropriate setting for the funds rate in the future.  While Fed officials argue that these are not rate projections, the markets correctly regard them as just that.  Common sense suggests that if one puts on paper a future path for rates, those are projections.

The goal was to shape expectations of the direction of policy and thereby allow markets and the economy to adjust in an orderly manner.  Apparently, it never occurred to the FOMC academics that markets are prone to overreacting to pronouncements from the Fed.  That is what is happening, and that forces Chair Powell and other officials to try to downplay the significance of the tenor of the dot charts.

Prior to the dot charts, market participants were very good, but not perfect, at predicting the direction of Fed policy.  Shifts in those predictions were far less disruptive than shifts in the dot charts.  Predictions from Fed officials have a much greater market impact, despite the fact that Fed forecasts have been no more accurate than private-sector forecasts.  Perhaps because the Fed’s projections are thought to be self-fulfilling.

Experience has shown, however, that the dot chart forecasts are not very prescient.  They have changed dramatically in response to unanticipated shifts in the economic data, and those changes have been disruptive–as in November-December.  It appears that the primary impact of this experiment in “Fed guidance” has been to focus too much attention on the admittedly flawed rate forecasts.  There are indications that FOMC members are frustrated by, but not sure how to improve this state of affairs.  Perhaps they should simply abandon the effort.

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