You Can’t Connect the [Fed’s] Dots Looking Forward

Many commentators view last week’s Fed meeting (including the FOMC statement, the Chair’s press conference, commentary from FOMC members) as another move toward more discretion and away from rules-based policy. Their reasoning is mainly based on the Fed’s change in forward guidance.  Rather than basing the future federal funds rate on a single quantitative measure—the unemployment rate—the Fed said it now would use a broader set of criteria without numerical quantities. John Cochrane wrote about this increased vagueness on his blog and Larry Kudlow and Rick Santelli asked me about it in interviews after the meeting.  They lamented the lack of rules-based policy, and so do I.

In my view the recent Fed statements convey about the same degree of discretion that the Fed has been continually engaged in since the panic of 2008 ended. That discretion is clearly revealed by the repeated changes in the forward guidance criteria every year since the recession. Here what the Fed said about the federal funds rate in the past six years.

Dec 2008: “Exceptionally low levels…for some time…”

Mar 2009: “…for an extended period…”

Aug 2011: “…at least through mid-2013…”

Jan 2012: “…late 2014…”

Sep 2012: “…through mid-2015…”

Dec 2012: “…at least as long as the unemployment rate remains above 6 ½ percent…”

March 2014:  “…the language that we use in this statement is considerable, period…. this is the kind of term it’s hard to define, but, you know, it probably means something on the order of around six months or that type of thing…”

With such rapid changes in operating procedures, there’s no way one can see a strategy or rule.  And this is coupled with the near impossibility of quantitative easing being conducted in a rule-like manner.

Was there any good news in this meeting for those who would like to see a return to a more rules-based policy? The Fed’s dots (individual forecasts of the future funds rate marked on a chart) are indicative. The meeting revealed some higher and earlier dots with no apparent corresponding change in forecasts for inflation or real GDP: The FOMC median forecast for the federal funds rate for the end of 2015 increased by .25 percentage points and the forecast for the end of 2016 increased by .5 percentage points.  These increases would bring policy slightly back in the direction of a rules based policy like the Taylor rule, which the Fed adhered to pretty closely in the past when policy worked well.

But we are a still long way off, and unfortunately there is no way using published material to connect the individual dots with individual forecasts of inflation and real GDP.  As Steve Jobs said (in a different context) in his famous speech to Stanford graduates in 2005 “you can’t connect the dots looking forward; you can only connect them looking backwards.”

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