Fed's Forward Guidance Is Increasing Market Volatility
The Federal Reserve’s forward guidance program has been a disaster, so much so that it has strained the central bank’s credibility. Chair Jerome Powell seems to agree that providing estimates of where the Fed sees interest rates, economic growth and inflation at different points in the future should be junked. “We think it’s time to just go to a meeting-by-meeting basis, and not provide the kind of clear guidance we had provided,” he said after the Fed’s July 26-27 monetary policy meeting.
When it began providing forward guidance almost 14 years ago, the Fed hoped that by making clear its intentions through its Quarterly Summary of Economic Projections and press conferences, it could avoid disruptive market shocks and reduce volatility. The financial meltdown of 2008 had revealed the opaqueness of the old system and the need for transparency. The central bank succumbed to the transparency pressures and in December 2008 began the use of forward guidance when it cut its overnight federal funds policy rate to near-zero and said it “will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability. In particular, the [Federal Open Market] Committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.”