Federal Reserve Chair Jerome Powell has indicated that the central bank’s communication will be part of its 2025 monetary policy review. That makes sense because Fed communication shapes market expectations about the future path of interest rates and affects financial conditions — key transmission channels of monetary policy.
The Powell-led Fed has generally received favorable grades on communication from academic economists and market participants. A 2024 Brookings Institution survey gave the Fed a median grade of B+, slightly lower than its 2020 survey but up from a B- score in 2016. More recently, however, criticism has increased. At last month’s press conference, many noted the dissonance between the Fed’s decision to cut rates versus the revisions to its forecasts showing solid economic growth and higher inflation in 2025.
Fed communications could be improved in several areas. First, the central bank’s flexible average inflation targeting (FAIT) regime lacks clarity. Officials have not indicated the period over which “average” applies nor how far they should allow inflation to run above 2% to reach a 2% average following periods when there has been a shortfall. Powell has hinted that this will be solved by ditching FAIT and moving back to always aiming for a 2% inflation outcome. This has two benefits, simplifying communication and eliminating the bias to be late to tighten monetary policy following periods when inflation has persistently been below 2%.
Second, the Fed’s Summary of Economic Projections, which shows the economic and interest rate forecasts of the 19 Federal Open Market Committee members, suffers from significant shortcomings. For example, FOMC members don’t necessarily work from a common set of assumptions. As Powell noted in last month’s press conference, some people incorporated the economic effects of President-elect Donald Trump proposed policies into their forecasts, some didn’t and some “didn’t say whether they did or not.”
And because individual economic projections for gross domestic product, the unemployment rate and inflation are not tied explicitly to the interest rate forecasts, it is difficult to discern whether the variations in interest rate projections are due to differences in the economic outlook versus differences in how the Fed should respond (in economists’ parlance — the Fed’s reaction function).
Finally, the SEP focuses on the modal economic forecast of each participant. This obscures differences in policymakers’ assessments of risk and uncertainty about how the economy might evolve and how policymakers might react if the modal forecasts don’t materialize.
Fixing these flaws in the SEP is difficult, which is why they persist. This suggests that a better way forward might be to develop and publish a consensus forecast as many other central banks do and deemphasize the SEP. Yet developing a consensus forecast that is timely and representative of the FOMC is hampered by its size and geographic diversity of the members. When the FOMC evaluated constructing a consensus forecast in 2012, major obstacles included the difficulty in producing an agreed-upon forecast in a timely way and a lack of agreement about how significant a disagreement to the consensus forecast would need to be to warrant a dissent.
Publishing the Fed’s staff forecast would circumvent these issues. It is available in a timely way and already serves as the benchmark for FOMC members’ individual forecasts. Although the Fed staff might be unenthusiastic about having its forecast be made public immediately (rather than released with a five-year lag as is currently the case), this approach has worked at the European Central Bank, which also has a large and geographically diverse membership, without any great difficulty. Moreover, the Fed staff forecast hardly remains a secret given that it is summarized in the FOMC minutes that are released three weeks after each meeting.
A second way to deemphasize the SEP’s modal forecasts would be to disclose alternate scenarios about how the economy might perform under various assumptions. This is already done regularly via the staff’s “alternative simulations” in its Tealbook that is distributed to Fed policymakers before each meeting. This would enable market participants to understand better how the Fed would likely respond to changes in the economic outlook due, for example, to shifts in trade and immigration policy.
Third, Fed officials should develop a coherent communication regime for quantitative easing (QE) and tightening (QT). This includes guidance about when QE should be undertaken to support market functioning versus to provide additional monetary policy stimulus when the Fed is constrained by the zero lower bound for short-term interest rates. It also should include an explicit cost-benefit framework so that market participants can better judge how changes in the economic outlook will influence the timing and magnitude of QE and QT.
The better the quality of the Fed’s communication the more accurately market participants can assess how policy is likely to change with economic circumstances. This tightens the linkage between the Fed’s monetary policy actions and financial conditions, which in turn increases the speed and precision of monetary policy transmission.
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