Coming Soon: Fed Interest Rate Forecasts?

It’s no secret that the Fed has already done about as much as it can to stimulate the economy. It has already made full use of its monetary policy tools. Not only has it slashed the Federal funds rate to near-zero levels, but it has also already dealt two rounds of quantitative easing.

So what do you do when you’ve pretty much exhausted all your resources? How do you communicate your intentions more efficiently with markets? You get creative. You recycle.

Recently, there have been talks that the Fed is revisiting its plans to provide actual forecasts for short-term interest rates. Fed Chairman Ben Bernanke and Janet Yellen, president of the Federal Reserve Bank of San Francisco, have been working closely with a communications committee to look into the possibility of rate forecasting, an idea that was initially proposed four years ago.

Now how in the heck will this help the economy? It’s quite simple, really. The Fed wants to improve transparency to better align the public’s expectations with its own.

You see, if investors begin speculating on tighter monetary policy before the Fed feels it’s appropriate, it could lead to a rise in interest rates. In turn, an ill-timed jump in interest rates could suffocate growth and weigh down the economy even further. Of course, this could be avoided if the Fed and investors were on the same page in the first place. And this is exactly what rate forecasting can address.

Fed with Crystal Ball

The communications strategy has been tried and tested by the central banks of Norway, New Zealand, and Sweden. However, some critics doubt that the Fed will be as successful at it as its counterparts.

They argue that market participants may see the forecasts as future commitments rather than mere projections based on current conditions which are temporary. For instance, if investors price in the Fed’s prediction of higher interest rates but the central bank ends up maintaining its easy monetary policy, it could result in instability in the markets.

Nonetheless, the skepticism hasn’t kept some market junkies from getting excited about the idea. Some even say that the Fed could begin releasing forecasts as early as its next meeting, which is on December 13. Yup, that’s next week!

If the move is implemented, there could be less speculation about what the Fed may do as markets will receive forecasts straight from the horse’s mouth. Heck, the central bank will practically be spoon-feeding the markets with its ideas!

Don’t get me wrong, I acknowledge that rate forecasting may help overall transparency and improve market efficiency. However, in this humble old man’s opinion, the Fed must first find a way to make sure that there is no confusion among market participants about the conditional nature of its forecasts.

The way I see it, unless everyone understands that the projections aren’t written in stone and will not necessarily warrant action from the Fed, this particular communications strategy may do more harm than good.