Reactions of real yields and inflation expectations to forward guidance in the United States

We study the impact of forward policy rate guidance by the Federal Reserve’s Federal Open Market Committee (FOMC) used as an unconventional monetary policy tool at the zero lower bound of the policy rate on real and breakeven US Treasury yield curves. We find that explicit FOMC policy rate guidance announcements led to a significant reduction in real yields at horizons of 2 to 5 years ahead. By contrast, long-term breakeven inflation rates were little affected, suggesting that inflation expectations have remained well anchored, and that explicit FOMC policy rate guidance has not adversely affected central bank credibility.     

Evaluating FOMC forecast ranges: an interval data approach

The Federal Open Market Committee (FOMC) of the U.S. Federal Reserve publishes the range of members’ forecasts for key macroeconomic variables, but not the distribution of forecasts within this range. To evaluate these projections, previous papers compare the midpoint of the range with the realized outcome. This paper proposes an alternative approach to forecast evaluation that takes account of the interval nature of projections. It is shown that using the conventional Mincer–Zarnowitz approach to evaluate FOMC forecasts misses important information contained in the width of the forecast interval. This additional information plays a minor role at short forecast horizons but turns out to be of sometimes crucial importance for longer-horizon forecasts. For 18-month-ahead forecasts, the variation of members’ projections contains information that is more relevant for explaining future inflation than information embodied in the midpoint. Likewise, when longer-range forecasts for real GDP growth and the unemployment rate are considered, the width of the forecast interval comprises information over and above the one given by the midpoint alone.     

THE POWER OF THE FEDERAL RESERVE CHAIR

This article examines the influence exerted by the Federal Reserve chair on monetary policy decisions. We construct a voting model where the chair selects the proposal that is initially put to a vote but is subject to an acceptance constraint that incorporates the preferences of the median Federal Open Market Committee (FOMC) member and the probability of counterproposals. The model is estimated by maximum likelihood using real-time data from FOMC meetings. Results for all chairs in our sample show that the chair's proposal is the result of a compromise, reflecting a stable balance of power within the FOMC.     

Is the Fed’s news perception different from the private sector’s?

The recent literature on monetary policy has dedicated considerable attention to modelling agents’ processing of information about the future in real time. This paper contributes to this growing strand by investigating the implied differences in the so-called news shocks estimated from the standard New Keynesian dynamic stochastic general equilibrium (DSGE) model using the real-time data sets from the Survey of Professional Forecasters (SPF) and the Federal Reserve’s Greenbook (GB) forecasts. Alternative specifications with either the SPF or GB forecasts aim to delineate the differences in the private sector’s and the Fed’s expectations of future macroeconomic outcomes and identify the differences in their perception of news shocks. Our results indicate that while the demand news shocks have very similar distributions in the two datasets, the monetary and cost-push news shocks from the models estimated on the GB data tend to be larger than those from the SPF. These findings suggest that the Federal Reserve’s forecasting methods allow for more variation in future outcomes than the SPF’s. These findings mesh well with the extant literature on the superiority of the Fed’s forecasts relative to the private sector’s and provide a structural explanation for the source of this superiority.     

Do FOMC forecasts add value to staff forecasts?

This paper compares the economic forecasts of members of the Board of Governors and presidents of the Federal Reserve Banks, and then investigates the value of each group's forecasts in supplementing the forecasts of the Board of Governors' staff. We find that the presidents tend to forecast higher inflation and real GDP growth, and lower unemployment than the members of the Board of Governors. We also find that the presidents' real GDP and unemployment rate forecasts add value to the real economy forecasts of the staff, while the governors' inflation forecasts add value to the staff's inflation forecasts.     

Forecast combination for discrete choice models: predicting FOMC monetary policy decisions

This paper provides a methodology for combining forecasts based on several discrete choice models. This is achieved primarily by combining one-step-ahead probability forecasts associated with each model. The paper applies well-established scoring rules for qualitative response models in the context of forecast combination. Log scores, quadratic scores and Epstein scores are used to evaluate the forecasting accuracy of each model and to combine the probability forecasts. In addition to producing point forecasts, the effect of sampling variation is also assessed. This methodology is applied to forecast US Federal Open Market Committee (FOMC) decisions regarding changes in the federal funds target rate. Several of the economic fundamentals influencing the FOMC’s decisions are integrated, or I(1), and are modeled in a similar fashion to Hu and Phillips (J Appl Econom 19(7):851– 867, 2004). The empirical results show that combining forecasted probabilities using scores generally outperforms both equal weight combination and forecasts based on multivariate models.     

On the accuracy of Federal Reserve forecasts of the budget deficit-output ratio

Monetary authorities, while unable to resolve fiscal imbalances, have to deal with their consequences in formulating monetary policy. This article asks whether the Federal Open Market Committee (FOMC) is provided with accurate forecasts of the federal budget deficit-output ratio. We show that the forecasts made in the period 1982 to 2002 are unbiased with useful predictive information above that contained in time-series forecasts.     

SCREENING FOMC MEMBERS FOR THEIR BIASES AND DEPENDABILITY

This paper develops conjectures regarding the process by which the President as a principal selects Federal Reserve Governors and Bank Presidents as his agents on the Federal Open Market Committee (FOMC). It first establishes that FOMC members can be grouped into sets which are marked by ease and tightness biases in voting behavior. It then identifies certain career characteristics of FOMC members which are correlated with each of these biases. The paper goes on to isolate reliable partisan subsets within the ease and tightness sets and identifies a career characteristic which is highly correlated with membership in these subsets; that characteristic is a career as an economist.     

Bayesian forecasting of federal funds target rate decisions

In this paper we examine which macroeconomic and financial variables have most predictive ability for the federal funds target rate decisions made by the Federal Open Market Committee (FOMC). We conduct the analysis for the 157 FOMC decisions during the period January 1990–June 2008, using dynamic ordered probit models with a Bayesian endogenous variable selection methodology and real-time data for a set of 33 candidate predictor variables. We find that indicators of economic activity and forward-looking term structure variables, as well as survey measures are most informative from a forecasting perspective. For the full sample period, in-sample probability forecasts achieve a hit rate of 90%. Based on out-of-sample forecasts for the period January 2001–June 2008, 82% of the FOMC decisions are predicted correctly.     

MONETARY POLICY COMMITTEES: MEETINGS AND OUTCOMES

Monetary Policy Committees (MPCs) differ in the way the interest rate proposal is prepared and presented in the policy meeting. In this paper, we show analytically how different arrangements could affect the voting behavior of individual MPC members and therefore policy outcomes. We then apply our results to the Bank of England and the Federal Reserve. A general finding is that when MPC members are not too diverse in terms of expertise and experience, policy discussions should not be based on preprepared policy options. Instead, interest rate proposals should arise endogenously as a majority of views expressed by the members, as is the case at the Bank of England and appears to be the case in the Federal Open Market Committee (FOMC) under Chairman Bernanke. (JEL E58, D71, D78)     

DID TIME INCONSISTENCY CONTRIBUTE TO THE GREAT INFLATION? EVIDENCE FROM THE FOMC TRANSCRIPTS

We use evidence from detailed records of FOMC deliberations to argue that time inconsistency theory can help explain the excessive monetary expansion that characterized Arthur Burns's tenure as Federal Reserve Chairman (1970–1978). The records suggest that the Fed perceived a Phillips curve tradeoff and political pressures that made it difficult to adopt disinflationary policies; the tendency toward excessively expansionary policy was exacerbated by the short-run planning horizon the Committee faced in each of its meetings. We argue that comparative static predictions of the time inconsistency model are consistent with the rise of inflation during the Burns years and its subsequent fall.     

EFFECTS ON INTEREST RATES OF IMMEDIATELY RELEASING FOMC DIRECTIVES

Prior to February 1994, the Federal Open Market Committee (FOMC) did not officially release its current Domestic Policy Directives to the public until after the next FOMC meeting, a lag of approximately 45 days. Thus, the public never knew the FOMC's latest decisions about short-run monetary policy. On 11 occasions between early 1989 and May 1993, however, the essence of the directives was "leaked" to the Wall Street Journal within one week of an FOMC meeting. This study tests Federal Reserve officials' original assertion that early release of directives would increase volatility in financial markets by creating announcement effects. The study finds some evidence of announcement effects in certain instances, but the assertion that an immediate release would "roil the markets" appears unfounded .     

Predictions of growth in U.S. corporate profits: Asymmetric vs. symmetric loss

This study evaluates the Federal Reserve and private forecasts of growth in corporate profits for 1984-2004. These forecasts are both rational and directionally accurate but suggest different loss structures. The Federal Reserve forecasts tend to significantly under-predict and imply asymmetric loss. The private forecasts, however, are free of such bias, suggesting symmetric loss. Given that the Federal Reserve forecasts are made to help with policymaking, our findings point to the Fed's cautiousness not to incorrectly predict the downward moves in growth in corporate profits. The private forecasts are made by experts who (with a strong profit-motivated interest) attempt to generate financial gain and thus predict the upward moves as accurately as the downward moves.     

Intermediate Macroeconomics without the IS-LM Model

The IS-LM model is the primary model of economic fluctuations taught in intermediate-level undergraduate macroeconomics. Recent works by Taylor and Romer make a strong case for an alternative model, known as the aggregate demand-price adjustment (AD-PA) or the aggregate demand-inflation adjustment (AD-IA) model, as a better model of economic fluctuations. The author argues that the AD-PA model is superior to the IS-LM model for teaching about economic fluctuations in intermediate macroeconomics. He compares the perfomance of the two models in teaching about two important issues in current macroeconomics: the ineffectiveness of monetary policy in stimulating the 1990s Japanese economy and the rapid switch of the U.S. Federal Reserve from contractionary policy to expansionary policy in 2001.     

The effect of FOMC statements on asset prices

Given their increased importance during recent years, FOMC (Federal Open Market Committee) statements can have a significant impact on asset prices. To capture the effect of FOMC statements on asset prices, an indicator variable is created that takes into account the information content of policy statements. Results show that both ‘interest rate surprises’ and ‘FOMC statements’ affect the mean and the volatility of asset prices. The volatility impact is tent-shaped, jumping within the policy announcement interval and declining before and after the release. FOMC statements have a much more pronounced impact on stock returns, intermediate and long-term yields, while short-term rates are largely driven by target rate decisions. We also find that the evolution of the language of the FOMC statements does matter to market participants and, in particular, the ‘forward-looking’ language adopted in mid-2003 has reduced market volatility associated with ‘interest rate surprises’ on announcement days.     

Taylor rules and the Great Inflation

Can US monetary policy in the 1970s be described by a stabilizing Taylor rule when policy is evaluated with real-time inflation and output gap data? Using economic research on the full employment level of unemployment and the natural rate of unemployment published between 1970 and 1977 to construct real-time output gap measures for periods of peak unemployment, we find that the Federal Reserve did not follow a Taylor rule if appropriate measures are used. We estimate Taylor rules and find no evidence that monetary policy stabilized inflation, even allowing for changes in the inflation target. While monetary policy was stabilizing with respect to inflation forecasts, the forecasts systematically under-predicted inflation following the 1970s recessions and this does not constitute evidence of stabilizing policy. We also find that the Federal Reserve responded too strongly to negative output gaps.