Behind the Fed Curtain

Wednesday, the Federal Reserve closed its first FOMC policy meeting of the year. But interestingly, most attention wasn’t on the decisions announced, but how they were presented.

The Fed announced intentions to maintain interest rates near zero through at least 2014. Likewise, the Fed intends to continue “Operation Twist” and maintain the relative size of its balance sheet. The Fed rationalized that while it believes the economy has grown moderately, still-elevated unemployment and low inflation mean an accommodative stance is warranted to meet its dual mandate (fostering maximum employment and stable prices). No surprises there.

However, seeking to quell fears that continuing accommodative monetary policy will stoke runaway inflation, the Fed announced it would follow the lead of other major central banks and publish an inflation target—2%. This was a departure from past statements. Yet, most media chose to focus on the Fed’s transparency initiative—the release contained the Fed’s initial foray into publishing the interest rate forecasts of each of the FOMC’s 17 voting members.

We applaud this incremental step toward increased transparency, but reserve judgment on whether it has any material impact. The peek behind the curtain is interesting to the Fed-wonk in us, but ultimately, the FOMC determines rates as a whole. And voting members can and do change direction over time—as they should! Further, whether it’s a market pundit or a Fed official, attempting to forecast economic, employment and inflation conditions years in advance to formulate a rate forecast involves a lot of guess work and assumptions. Trying to determine economic direction for the year ahead and the appropriate monetary response is tough enough, never mind looking out much past that. For that reason, the Fed’s forecasts are likely pretty far from a true roadmap. Still, removing some of the mystery of what goes into a Fed statement likely reduces some market uncertainty. We just caution anyone from taking those longer-term forecasts to the bank.