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Dot plots for the Eurosystem?
Speech at Harvard University

22.10.2024 I Cambridge I Joachim Nagel

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1 Introduction
2 The dot plot and other forms of forward guidance
2.1 The Fed's dot plot
2.2 Monetary policy communication at the Eurosystem
3 A dot plot for the Eurosystem?
3.1 Independence
3.2 Effectiveness of monetary policy communication
3.3 Projection uncertainty

4 Conclusion

1 Introduction

Ladies and gentlemen,

it is a great pleasure to be at Harvard again, to meet long time companions like
Hans-Helmut Kotz and to exchange ideas with top scientists such as Benjamin
Friedman. When I was in this round two years ago, we were dealing with an
unprecedented global inflation spike.[1] Fortunately, the worst is behind us, and
inflation in the euro area is heading back to the Eurosystem's target. We have not
brought the inflation ship safely back into the 2% harbour, but the port is in sight.
Thus, I can focus on another question today.

Before I do that, let me share an analogy to set the stage for my discussion. Back in
the 1970s and 1980s, the field of economics was split into two seemingly incompat-
ible schools of thought: New Keynesian and New Classical. Their proponents were
not too polite in their language, calling assumptions "foolishly restrictive" or com-
paring an opponent to someone attempting to pass himself off as Napoleon
Bonaparte.[2] But, over time, ideas from both camps ultimately merged to form a
consensus called the New Neoclassical Synthesis, the very foundation of modern
macroeconomics.[3] Gregory Mankiw neatly described this story in his essay "The
Macroeconomist as Scientist and Engineer" .[4]

The takeaway from this analogy is that complex issues are rarely black or white.
With this in mind, I want to explore whether the conduct of monetary policy in the
euro area could be enhanced by offering more detailed and nuanced information
regarding its future outlook. More specifically, today I will address the following
question: Should the Eurosystem introduce dot plots?

To explore this, I will first examine current experience with dot plots and other forms
of forward guidance in both the United States and the euro area. I will then evaluate
the advantages and disadvantages of incorporating dot plots into the Eurosystem's
communication strategy. In this analysis, I will concentrate on the implications for
policymakers' independence, the effectiveness of monetary policy and the manage-
ment of uncertainty.

2 The dot plot and other forms of forward guidance

Let me begin with some basics. Most central banks in advanced economies have a
clear mandate to keep prices stable. They do this mainly by setting the policy rate
and communicating their decisions in order to manage the expectations of eco-
nomic agents, including market participants, households and firms. When central
banks provide explicit signals about the future path of the policy rate, we call it
forward guidance.

We can classify forward guidance into two ideal types: "Odyssean" and "Delphic" .[5]
Odyssean forward guidance means the central bank makes a firm commitment to a
future course of action, like promising to keep interest rates at a certain level for a
certain time. Like Odysseus, who famously tied himself to the mast of his ship to
resist the call of the sirens, central banks are committing to staying on course -
whatever the future brings.

In contrast, Delphic forward guidance is conditional and involves sharing information
about the central bank's economic outlook and policy intentions without making
firm commitments. This term comes from the Oracle of Delphi, famous for its
prophecies and predictions, which were so ambiguous and open to interpretation
that they always seemed to be borne out in hindsight. A prime example of Delphic
forward guidance is the policy rate forecasts published by central banks such as
Norges Bank and Sweden's Riksbank.

A more subtle way of monetary policy communication is through the central bank's
reaction function. A reaction function indicates how the central bank adjusts its
policy rate in response to key macroeconomic variables like the inflation rate or eco-
nomic growth. When economic agents have a clear understanding of this reaction
function, communication about the expected development of these macroeconomic
variables can also help shape their expectations regarding the future trajectory of
the policy rate.

2.1 The Fed's dot plot

To consider if the Eurosystem should introduce dot plots, let me briefly recall what
the Fed (Federal Reserve System) dot plots are and how market observers view them.
Twelve years ago, the Fed (Federal Reserve System) began publishing the federal
funds rate projections of the Federal Open Market Committee

(FOMC (Federal Open Market Committee)) participants. Its intention was to boost
transparency and communication with financial markets and the general public. On
the other side of the Atlantic, the Eurosystem has, from its inception, held public
press conferences and published monetary policy statements, the minutes of its
meetings, and the results of its quarterly macroeconomic projections.

As you are well aware, before the FOMC (Federal Open Market Committee) meeting,
FOMC (Federal Open Market Committee) participants share their individual assess-
ment of the appropriate level of the fed funds rate for the end of the current year,
the end of the coming two to three years and over the longer run. The longer run
projection refers to "each participant's assessment of the value to which each vari-
able would be expected to converge, over time, under appropriate monetary policy
and in the absence of further shocks to the economy." [6]

Due to its visual representation in the Summary of Economic Projections (

SEP (Summary of Economic Projections)), the combined projections of all

FOMC (Federal Open Market Committee) members are known as the dot plot. These
dots complement the FOMC (Federal Open Market Committee) participants' projec-
tions for GDP (gross domestic product) growth, unemployment and inflation. While
each FOMC (Federal Open Market Committee) participant submits their funds rate
projection together with corresponding projections for macroeconomic variables,
these correspondences are not revealed by the

SEP (Summary of Economic Projections). Accordingly, market observers cannot
directly link the interest rate projections to the projections of the other macro
variables.

The dot plot was meant to complement the Fed's communication, not to replace the
forward guidance it provided in the monetary policy statement at that time during
the press conference. For example, in January 2012, the

FOMC (Federal Open Market Committee) statement provided explicit forward guid-
ance on rates, saying that the Committee "[...] anticipates that economic conditions
[...] are likely to warrant exceptionally low levels for the federal funds rate at least
through late 2014."[7] During the accompanying press conference, Chairman Ben
Bernanke introduced the dot plot, observing that "[...] eleven participants expect
that the appropriate federal funds rate at the end of 2014 will be at or below 1
percent, while six participants anticipate higher rates at that time." [8]

Although the Federal Reserve did not introduce the dot plots as an explicit tool for
forward guidance, many market analysts began to interpret them as such. When the
forward guidance in the statement and the dot plot sent mixed signals,

FOMC (Federal Open Market Committee) chairs often downplayed the dot plot's
importance.

In 2014, Janet Yellen famously stated: "[...] one should not look to the dot plot, so
to speak, as the primary way in which the Committee wants to or is speaking about
policy [...]."[9] Similarly, in 2019, Jerome Powell noted that "[...] the dot plot has, on
occasion, been a source of confusion. Until now, forward guidance in the statement
has been a main tool for communicating committee intentions and minimizing that
confusion." [10]

And this is also how Fed (Federal Reserve System) watchers now see the dot plot,
ranking it as the Fed's fifth most important communication tool.[11] The top com-
munication tools are the press conference, the Summary of Economic Projections
(excluding the dots), the FOMC (Federal Open Market Committee) statement, and
speeches by the chair.

Numerous studies show that the Fed (Federal Reserve System) has successfully used
monetary policy communication to influence long-term interest rates and other asset
prices.[12] And some research suggests that the dot plots significantly and indepen-
dently influence market interest rates. [13] But there is a fundamental issue about
these results: it is very challenging to determine how much each communication
channel contributes to the overall effect.

To identify the causal effect of monetary policy, scholars often define a so-called
event window around central banks' monetary policy meetings. Changes in market
interest rates during this event window are then attributed to monetary policy.

But there is a problem: when the dot plot is released, it is published together with
the monetary policy statement. That makes it hard to determine which one caused
the interest rate changes observed during the event. And because of this, it is
unclear whether those channels actually provide complementary information or are
just substitutes.

2.2 Monetary policy communication at the Eurosystem

So, what does the Eurosystem's monetary policy communication look like? The
Eurosystem began using explicit forward guidance in the introductory statement to
its July 2013 meeting. At that time, inflation in the euro area was low, and the
Eurosystem expected underlying price pressures to stay subdued in the medium
term. Interest rates were already at the effective zero lower bound.

To provide further accommodation, the ECB (European Central Bank)'s Governing
Council, which is the counterpart of the FOMC (Federal Open Market Committee),
announced in its July 2013 meeting that it "expects the key

ECB (European Central Bank) interest rates to remain at present or lower levels for
an extended period of time."[14] The Governing Council continued to use variations
of this statement for almost a decade. And there is now also ample evidence that
the Eurosystem has been successful in implementing its forward guidance.[15]

With the resurgence of inflation in 2021 and high uncertainty caused by major
shocks and structural changes, the Eurosystem shifted to a data-dependent,
meeting-by-meeting approach, largely stepping away from explicit forward
guidance.

More specifically, we now base our interest rate decisions on three elements: first,
our assessment of the inflation outlook in light of the incoming economic and finan-
cial data, second, the dynamics of underlying inflation, and third, the strength of
monetary policy transmission. These three elements can be seen as a further specifi-
cation of our reaction function. However, the Governing Council does not pre-
commit to any specific rate path.

Taken together, apart from the publication of the dot plot, the approaches to mone-
tary policy communication taken by the Federal Reserve System and the Eurosystem
are largely comparable. Both institutions regard the monetary policy statement and
the press conference as their primary communication tools. And both central banks
have recently shifted from explicit forward guidance towards a data-dependent
meeting-by-meeting approach.

But the Eurosystem also continues to provide signals about future policy rates. It
simply does it more implicitly. For example, the wording of the monetary policy
statement and the answers of the ECB (European Central Bank) President during
press conferences provide insights into future policy rates. As do speeches and inter-
views given by Governing Council members. Additionally, the Eurosystem influences
market expectations through its quarterly staff projections.[16]

Unlike some other central banks, the Eurosystem uses the interest rate implied by
financial market prices on a specific cut-off day as a conditioning assumption for its
macroeconomic projections. Specifically, this means that our medium-term inflation
forecast aligns with market expectations for a particular policy rate path. Market
participants can subsequently compare the exogenous path for the policy rate, as
embedded in our macroeconomic projections, with our actual monetary policy deci-
sions, in order to gain insights into our reaction function.

You could say that the Eurosystem provides Athenian communication. Athena was
known as the Goddess of wisdom and as a protector and guide to many Greek
heroes. Rather than communicating directly with those she protected, Athena often
used indirect guidance. And through her subtle guidance, Athena empowered the
heroes she protected to take decisive action and make wise choices.

3 A dot plot for the Eurosystem?

Now, let us get to the heart of the matter. Should the Eurosystem introduce dot
plots? Although this question can only be answered "yes" or "no", complex issues
are rarely black and white, as mentioned earlier.

In the following, rather than simply listing the pros and cons of introducing dot plots
in the Eurosystem, I will structure my discussion around three themes: First, the
impact dot plots could have on the independence of the Eurosystem. Second, the
potential for dot plots to improve the effectiveness of our monetary policy commu-
nication. And third, the role dot plots could play in capturing projection uncertainty
around our baseline forecasts.

Throughout, I will only consider adding projections for the policy rates to the exist-
ing macroeconomic projections by Eurosystem staff. For simplicity, I will not consider
whether to also complement our current consensus projections for macroeconomic
variables with individual macroeconomic projections.

3.1 Independence

Let me begin with the theme of independence. The ECB (European Central Bank)'s
Governing Council consists of the six ECB (European Central Bank) Executive Board
members and the 20 governors of the euro area's national central banks. Although
this setting may resemble that of the Federal Open Market Committee, which
includes Federal Reserve Bank Presidents, there is a significant difference.

The euro area is not composed of regions within a single country but of individual
countries within a larger union, each with its own fiscal authority and national laws,
as well as considerable differences in economic size and performance. Therefore,
within the Governing Council we have a strong interest in finding and communicat-
ing a consensus perspective. This is, for example, enshrined in our statute, which
states that the proceedings of the meetings of the Governing Council are
confidential.

When we discussed introducing ECB (European Central Bank) accounts from our
Governing Council meetings - comparable to the published minutes of

FOMC (Federal Open Market Committee) meetings - about a decade ago, we aimed
to balance two things: On the one hand, to clearly articulate the consensus perspec-
tive. Yet on the other hand to represent the full spectrum of views in order to help
market participants better understand the ECB (European Central Bank) Governing
Council's decision-making process.[17]

In the end, the Eurosystem decided to represent the full spectrum of the discussion
without naming individuals. Nevertheless, despite the anonymity of the arguments
presented, markets and the media alike continue to attempt to discern the identities
of the individuals behind them. Given that numerous members of the Governing
Council express their views on monetary policy through speeches and interviews,
identifying their positions is not a particular challenge.

If there were anonymous dot plots of Governing Council members, media and the
markets alike would probably attempt to match individual members to each dot as
well. The primary distinction between speeches and dot plots is that Governing
Council members deliver speeches voluntarily. In contrast, dot plots would force all
Governing Council members to regularly articulate their perspectives on the future
trajectory of interest rates. And this could potentially influence the Governing
Council's independence.

Once national stakeholders become aware of "their" representative's views on

future interest rates, they may exert pressure on the representative to align with
national interests. I am confident that, even if we were to publish dot plots, every
member of the Governing Council would continue to act independently and in the
best interests of the entire euro area. However, I believe we are well advised not to
put ourselves in a situation that might increase pressure on us to act in ways others
want us to.

3.2 Effectiveness of monetary policy communication

My second theme is whether a dot plot could significantly enhance the Eurosystem's
effectiveness of monetary policy communication. And here I am sceptical. To begin
with, there is the previously discussed issue: the dot plot may conflict with the con-
sensus message conveyed in the monetary policy statement. But the main reason for
my scepticism is that comparative studies on different methods of monetary policy
communication are inconclusive.

A BIS (Bank for International Settlements) working paper shows that interest rate
projections provide additional information to macroeconomic projections, meaning
that they are not redundant.[18] That could be seen as an argument for introducing
dot plots. However, while market participants in countries that publish both interest
rate projections and macroeconomic projections prefer the former, they might still
be able to obtain sufficient information from macroeconomic projections alone.

Furthermore, research on central bank communication in Norway and Sweden
shows that publishing interest rate projections has not improved market understand-
ing of what new macroeconomic information implies for future interest rate.[19] In
other words, the publication of interest rate paths did not help market participants
better understand the central banks' reaction functions.

This finding aligns with research published by the Reserve Bank of New Zealand that
shows that announcements with interest rate forecasts and those with only written
statements lead to similar market reactions across the yield curve.[20] The authors
pointedly conclude that, while central bank communication is important, the exact
form it takes is less relevant.

This result echoes a seminal study by Blinder and co-authors, who concluded back in
2008 that there was no consensus on what constitutes an optimal communication
strategy.[2 1]

All things considered, I see no compelling evidence that the Eurosystem's monetary
policy communication would be significantly enhanced by the introduction of a dot
plot.

3.3 Projection uncertainty

Now to the third and final theme - uncertainty. I am quite sure that the Eurosystem
has room to improve how we handle projection uncertainty. Currently, the

ECB (European Central Bank)'s Governing Council summarises its view on the uncer-
tainty surrounding economic growth and inflation in the risk assessment section of
its monetary policy statement. More specifically, the Eurosystem addresses the
uncertainty around its baseline inflation forecast in two ways.[22]

First, it produces fan charts with symmetric ranges around the point forecast, based
on past projection errors. In this setup, past projection errors act as a catch-all proxy
for uncertainty. Second, it occasionally publishes risk scenarios, conditional on
assumptions different from those in the baseline projection. For instance, during the
pandemic, the Eurosystem began using alternative assumptions about the future
path of infections and contact restrictions to illustrate macroeconomic uncertainty.

Could the use of dot plots enhance the communication of inflation forecast uncer-
tainty within the Eurosystem? Given that dot plots offer only an indirect method for
conveying uncertainty about the inflation outlook, there may be more effective
alternatives.

One might be to enhance the communication of our existing measures of uncer-
tainty. Another might be to develop new measures, such as scenario and sensitivity
analyses, as well as improved fan charts. We must carefully evaluate the pros and
cons of each approach.

Hence, it is quite fitting that the Eurosystem is currently performing an interim
strategic review, which includes an analysis of how risk and uncertainty should
inform both policy decisions and policy communication. I'm already looking forward
to the results.

4 Conclusion

Ladies and gentlemen, let me conclude. I began my talk by discussing different
schools of thought - New Keynesian and New Classical - and argued that complex
issues are rarely black or white. When it comes to central bank communication
about the future, there are certainly many promising approaches. And, undoubtedly,
dot plots are an intriguing instrument for central bank communication.

However, given the prevailing evidence, I do not see a compelling case for introduc-
ing dot plots for the Eurosystem.

On the other hand, I firmly believe that we can and should enhance how we
account for uncertainty in our macroeconomic projections. I have outlined a few
options which the Eurosystem will address in the ongoing strategy review.

Footnotes:

1. Nagel, J. (2022), The ECB (European Central Bank)'s mandate: maintaining price
stability in the euro area, speech at the Minda de Gunzburg Center for European
Studies, Harvard University.

2. Mankiw, G. (2006), The Macroeconomist as Scientist and Engineer, Journal of
Economic Perspectives, Vol. 20(4), pp. 29-46.

3. Goodfriend, M. and R. King (1997), The New Neoclassical Synthesis and the Role
of Monetary Policy, in: NBER (National Bureau of Economic Research)
Macroeconomics Annual, Bernanke, B. and J. Rotemberg (eds.),

MIT (Massachusetts Institute of Technology) Press, pp. 231-283.

4. Mankiw, G. (2006), op. cit.

5. Campbell, J. et al. (2012), Macroeconomic Effects of Federal Reserve Forward
Guidance, Brookings Papers on Economic Activity, Vol. 43(1), pp. 1-80. Another
distinction is between time-dependent (or calendar-dependent) and state-depen-
dent forward guidance. The former ties monetary policy to a specific time frame,
whereas the latter ties future policy actions to specific economic conditions or
thresholds. The concepts can overlap and be used in combination.

6. SEP (Summary of Economic Projections): Compilation and Summary of Individual
Economic Projections, 24-25 January 2012.

7. FOMC (Federal Open Market Committee) Statement, 25 January 2012.

11.

12.

13.

14.

15.

16.

17.

. Bernanke, B. (2012), Transcript of Chairman Bernanke's Press Conference, 25

January 2012,

. Yellen, J. (2014), Transcript of Chair Yellen's Press Conference, 19 March 2014.
. Powell, J. (2019), Monetary Policy: Normalization and the Road Ahead, speech at

the SIEPR (Stanford Institute for Economic Policy Research) Economic Summit,
Stanford Institute of Economic Policy Research, Stanford, California.

Wessel, D. and S. Boocker (2024), Federal Reserve communication - survey
results, Hutchins Center on Fiscal and Monetary Policy at Brookings.

See, for example, Gurkaynak, R. et al. (2005), Do Actions Speak Louder Than
Words? The Response of Asset Prices to Monetary Policy Actions and
Statements, International Journal of Central Banking, International Journal of
Central Banking, Vol. 1(1), pp. 55-93; Wright, J. (2012), What Does Monetary
Policy Do to Long-term Interest Rates at the Zero Lower Bound?, Economic
Journal, Vol. 122(564), pp. 447-466; and Swanson, E. (2021), Measuring the
effects of federal reserve forward guidance and asset purchases on financial
markets, Journal of Monetary Economics, Vol. 118(C), pp. 32-53.

See, for example, Couture, C. (2021), Financial market effects of

FOMC (Federal Open Market Committee) projections, Journal of
Macroeconomics, Vol. 67 and Hillenbrand, S. (2023), The

Fed (Federal Reserve System) and the Secular Decline in Interest Rates, Accepted,
Review of Financial Studies.

Draghi, M. and V. Constancio (2013), Introductory statement to the press confer-
ence (with Q&A), Frankfurt am Main, 4 July 2013.

See, for example, Altavilla, C. et al. (2021), Assessing the efficacy, efficiency and
potential side effects of the ECB (European Central Bank)'s monetary policy
instruments since 2014, ECB (European Central Bank) Occasional Paper, No. 278;
Andrade, P. and F. Ferroni (2021), Delphic and Odyssean monetary policy shocks:
Evidence from the euro area, Journal of Monetary Economics, Vol. (117), pp.
816-832; Kerssenfischer, M. (2022), Information effects of euro area monetary
policy, Economics Letters, Vol. 216(C); and Monetary Policy Committee,
Taskforce on Rate Forward Guidance and Reinvestment (2022), Rate forward
guidance in an environment of large central bank balance sheets: A Eurosystem
stock-taking assessment, ECB (European Central Bank) Occasional Paper No.
290.

The Eurosystem produces macroeconomic projections four times a year.

ECB (European Central Bank) staff produces them in March and September. In
June and December, they are co-produced by ECB (European Central Bank) and
national central bank staff.

See Morris, S. and H. Shin (2005): Central Bank Transparency and the Signal
Value of Prices, Brookings Papers on Economic Activity, Vol.36(2), pp. 1-66 for a
general treatment of the role of transparency.

18.

19.

20.

21.

22.

Hofmann, B. and D. Xia (2022), Quantitative forward guidance through interest
rate projections, BIS (Bank for International Settlements) Working Paper No.
1009.

Natvik, G. et al. (2020), Does publication of interest rate paths provide guid-
ance?, Journal of International Money and Finance, Vol. 103.

Detmers, G.-A (2021), Quantitative or Qualitative Forward Guidance: Does it
Matter?, Economic Record, Vol. 97(319), pp. 491-503.

Blinder, A. et al. (2008), Central Bank Communication and Monetary Policy: A
Survey of Theory and Evidence, Journal of Economic Literature, Vol. 46(4), pp.
910-945.

See ECB (European Central Bank) (2024), ECB (European Central Bank) staff
macroeconomic projections for the euro area, March 2023, box 6 for a
rundown.