For release on delivery
5:00 p.m. EDT
April 17, 2017
Monetary Policy Expectations and Surprises
Remarks by
Stanley Fischer
Vice Chairman
Board of Governors of the Federal Reserve System
at the
School of International and Public Affairs
Columbia University
New York, New York
April 17, 2017
I will address the topic of central bank communications, with a particular
emphasis on those times when financial markets and the central bank have different
expectations about what a central bank decision will be. Such situations lead to surprises
and often to market volatility.
Of course, not all surprises are equal. For one, communications that shift or
solidify expectations that are diffuse or not strongly held are less likely to be disruptive
than communications that run counter to strongly held market beliefs. Further, there are
worse things than surprises. The central bank must provide its views regarding the likely
evolution of monetary policy, even when this view is not shared by market participants.
A concern for surprising the market should not be a constraint on following or
communicating the appropriate path of monetary policy. That said, there are good
reasons to avoid unintended surprises in the conduct of policy.1
Why should central banks avoid surprising financial markets? In recent decades,
it has been increasingly acknowledged that monetary policy implementation relies
importantly on the management of market expectations.2 In theory, clarity about the
central bank's reaction function--that is, how the central bank adjusts the stance of
monetary policy in response to changing economic conditions--allows the market to alter
financial conditions smoothly. This typically helps meet the bank's policy targets, with
the result that the markets are working in alignment with the policymaker's goals. Under
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this theory, repeated market surprises that raise questions about the central bank's
reaction function could threaten to disrupt the relationship between the central bank and
the markets, making the central bank's job more difficult in the future.3
How can the Fed avoid surprising markets? Clear communication of the Federal
Open Market Committee's (FOMC's) views on the economic outlook and the likely
evolution of policy is essential in managing the market's expectations. The Committee
has a number of communication outlets, including the policy statement, the Chair's news
conference, and the Summary of Economic Projections (SEP). The SEP in particular has
been useful in providing information on policymakers' assessments of the potential
growth rate of the economy and r*, the equilibrium real interest rate, both of which help
guide the market's expectations of the eventual path of policy.
However, avoiding unintended market reactions has not always been easy. The
example that immediately comes to mind is the taper tantrum of mid-2013. To recap,
over the course of May and June in 2013, the yield on 10-year Treasury securities
increased almost 1 percentage point amid increased market discussion of the eventual
tapering of Fed asset purchases and some key communications on the topic (figure 1).4
In particular, the 10-year yield rose about 10 basis points after then Chairman Bernanke
discussed tapering in public for the first time during the question-and-answer session of
his Joint Economic Committee testimony on May 22, commenting that the FOMC could
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reduce the pace of purchases "in the next few meetings" if it saw continued improvement
in the labor market that it was confident would be sustained.5 Yields rose even more
sharply after the June FOMC meeting, when, during his postmeeting press conference,
Chairman Bernanke noted that if the economy evolved as expected, the FOMC
anticipated reducing the pace of purchases in the latter part of 2013 and halting purchases
altogether by the middle of 2014.6
Information gathering is an important part of managing market expectations--for
the simple reason that you do not know if you are going to surprise the market unless you
have a good estimate of what the market is expecting. A remarkable feature of the taper
tantrum is that it was a surprise that should not have been a surprise, at least from the
perspective of the information the FOMC had at the time.
In assessing market expectations for policy, the FOMC reviews a variety of
market indicators and also draws heavily on the Federal Reserve Bank of New York's
Survey of Primary Dealers, whose respondents are the market makers in government
securities and the New York Fed's trading counterparties. This survey, conducted about
one week prior to each FOMC meeting, gauges primary dealers' expectations about the
economy, monetary policy, and financial market developments.7
In the June 2013 primary dealer survey, the median expectation was for tapering
to start in December 2013, with purchases ending in June 2014, a path not significantly
different from that laid out by Chairman Bernanke in his postmeeting press conference.
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Thus, one could view Chairman Bernanke's remarks during his June 2013 press
conference as consistent with "market expectations."
Why did markets react so sharply to the apparent confirmation of the median
expectation? One simple possibility is that the median expectation of the primary dealers
was not reflective of the median expectation of a wider range of market participants.
Respondents to the primary dealer survey are more likely to be Fed watchers and
therefore more likely in tune with Fed thinking than the average market participant. For
example, as seen in figure 2, a comparison of the June 2013 primary dealer survey with
the contemporaneous Blue Chip Economic Indicators survey, which draws from a wider
sample of forecasters, reveals that Blue Chip respondents were more likely to expect a
later start of tapering and thus more likely to have been surprised by Chairman
Bernanke's communications.
In a related argument, former Federal Reserve Board Governor Jeremy Stein gave
an insightful speech in May 2014 addressing how diversity in market expectations could
have contributed to the taper tantrum.8 Jeremy pointed out that it is unhelpful to view the
"market" as a single individual, a theme that has been explored by Hyun Song Shin of the
Bank for International Settlements.9 Rather, the market is a collection of agents that can
have widely divergent but perhaps strongly held beliefs at the individual level. Jeremy
attributes the taper tantrum to the existence of highly leveraged quantitative easing
optimists--in other words, individuals who expected the Federal Reserve to continue to
accumulate assets much longer than the median expectation and who put little weight on
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the median market expectation. Once Chairman Bernanke affirmed the median
expectation, these optimists had to quickly unwind their trades, with consequent sharp
movements in asset prices.
Where does that leave us? The problem, to quote Jeremy at length, "is that in
some circumstances there are very real limits to what even the most careful and deliberate
communications strategy can do to temper market volatility. This is just the nature of the
beast when dealing with speculative markets, and to suggest otherwise--to suggest that,
say, 'good communication' alone can engineer a completely smooth exit from a period of
extraordinary policy accommodation--is to create an unrealistic expectation."10
Jeremy was speaking about ending the accumulation of assets onto the Fed's
balance sheet. As reported in the minutes for the March 2017 meeting, the FOMC is now
discussing a different inflection point, the phasing out of reinvestment and the shrinking
of the balance sheet.11 Question: How concerned should we be about a repeat of the
taper tantrum as we move through this new inflection point?
We should start answering such a question by recognizing that there is always a
chance of some market volatility. Nonetheless, we need to take into account that the
New York Fed's Open Market Desk enhanced its information-gathering efforts after and,
in part, as a response to the experience of the taper tantrum along two important
dimensions. First, in 2014, the Desk augmented its Survey of Primary Dealers with a
Survey of Market Participants, going some way to addressing concerns that primary
dealers alone were not providing sufficient coverage of market beliefs.12 Second, more
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recently, questions have been added to the surveys to identify uncertainty about
reinvestment policy for each individual survey respondent and not just the dispersion of
beliefs about the expected change across respondents.
Starting with the market participant survey, as I noted earlier, one informational
constraint that complicated the Fed's understanding of market dynamics around the taper
tantrum was the possible divergence of beliefs between the primary dealers, who were
surveyed, and the market at large. The differences between the expectations of the
primary dealers and those of the panel for the Blue Chip Economic Indicators, shown in
figure 2, provide some support for the view that the primary dealers' views may well
have differed from those of a wider range of market participants, but it would have been
preferable to have a poll of market participants rather than forecasters. Not long after the
taper tantrum, in January 2014, the Desk began its separate Survey of Market
Participants. The survey panel currently consists of 30 so-called buy-side firms,
including hedge funds and asset managers.
Turning now to measures of individual uncertainty, in the April 2013 primary
dealer survey, just prior to the taper tantrum, dealers were mostly questioned on their
point estimates regarding the timing and conditions under which tapering would
commence. Respondents were asked to provide their expectation for the monthly pace of
asset purchases after each of several upcoming policy meetings. They were also asked to
provide point estimates, or estimates of single particular values, for the quarter and year
during which they expected asset purchases in Treasury and agency mortgage-backed
securities to be completed. While these questions did provide some notion of the
variation in beliefs across respondents, they did not provide much information on how
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strongly these beliefs were held by the individual respondents, nor on the extent to which
their individual beliefs might have been reflected in the size of their market positions and,
in particular, the amount of leverage underlying those positions.13
In contrast, the most recent primary dealer and market participant surveys,
conducted prior to the March 2017 FOMC meeting, asked survey participants to indicate
their view of their own uncertainty over several different aspects of policy. For example,
in addition to their point estimates, participants were asked to indicate the percent chance
they assigned to the federal funds rate being at various levels when the FOMC first
announces a change to the reinvestment policy. They were also asked to assign
probabilities to different dates for the first announced change in reinvestment policy.
Why is this information important? To go back to Jeremy Stein's argument about
the taper tantrum, Jeremy pointed out that market participants' expectations for tapering
varied widely, but he conjectured that some of the participants were very certain in their
expectations and that it was primarily their reaction that fueled the taper tantrum. When
the surveys reported only point estimates, we had a measure of dispersion across market
participants, but we were in the dark on how firmly held these beliefs were. By asking
participants to provide a distribution of outcomes, we also obtained a measure of how
certain they are of a particular outcome.
To highlight some results from the March 2017 surveys, as shown in figure 3, the
primary dealers' median projection for the level of the target federal funds rate when the
FOMC first announces a change in its reinvestment policy was reported to be
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1.63 percent. The 25th percentile of the distribution across respondents was 1.38 percent,
and the 75th percentile was 1.88 percent, suggesting a fairly tight range around the
median expectation. The reported range was even tighter for the market participants
around a median projection of 1.63 percent.
However, it would be a mistake to infer from the narrowness of these ranges a
firmness in expectations. As shown in figure 4, when respondents of each survey were
asked to indicate the percent chance assigned to different fed funds target levels when the
change in policy is announced, the average of all of their reported distributions was wide
and flat. The primary dealer survey places roughly equal weight on rates between 1.26
and 2.00 percent. In the underlying nonpublic data for the individual responses, the
reported distributions were somewhat narrower but still reflected significant uncertainty,
with no primary dealer placing more than 50 percent probability on any particular target
range. Like the dealers, the market participants also report wide individual distributions
of beliefs.
Likewise, when primary dealers were asked about the timing of the announced
change in reinvestment policy, the average of their responses was a relatively flat
distribution of possible dates, with almost equal probability on the announcement
occurring in the fourth quarter of 2017, the first two quarters of 2018, or the second half
of 2018 (figure 5). Again, the individual distributions were narrower but still showed a
significant amount of uncertainty. Highlighting the usefulness of also surveying market
participants, expectations in the market survey are distinctly shifted toward an early
announcement date relative to the expectations of the primary dealers.
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The surveys reveal that while beliefs are dispersed across participants,
importantly individual survey participants are also significantly uncertain--in other
words, any given participant does not appear to have firmly decided on the likely path of
policy. The general point is that while we often measure and report differences in views
across individuals, the uncertainty that individuals feel internally is also relevant. Recent
survey results that show that market participants assign a positive probability to a wide
range of outcomes also suggest that the factors that exacerbated the taper tantrum--
dispersed but firmly held beliefs--may be less pronounced in current circumstances than
they were at the time of the taper tantrum.
The market reaction to the release of the minutes of the March 2017 FOMC
meeting supports this interpretation of the interaction of uncertainty and Fed policy
communications. The minutes reported that, "provided that the economy continued to
perform about as expected, most participants anticipated that gradual increases in the
federal funds rate would continue and judged that a change to the Committee's
reinvestment policy would likely be appropriate later this year."14 As was shown in
figure 5, in the March 2017 surveys, respondents placed the most weight, 71 percent for
the primary dealers and 57 percent for the market participants, on an announced change
in reinvestment policy not occurring until 2018 at the earliest. Presumably, the April
survey will reveal a shift in these distributions.
It is noteworthy, however, that even though the statement in the minutes of the
March FOMC meeting regarding Committee members' expectations for announcing
changes in the reinvestment policy was not aligned with market expectations, there was
14
See Board of Governors (2017), p. 3.
only a muted market reaction.15 Perhaps in part, that is because the market participant
survey actually revealed a considerable amount of weight, though not the majority, on an
announcement occurring this year. Or it is also possible that the diffuse expectations on
timing prior to the release of the minutes were a factor in tamping down market volatility
as market participants adjust their expectations.16
My tentative conclusion from market responses to the limited amount of
discussion of the process of reducing the size of our balance sheet that has taken place so
far is that we appear less likely to face major market disturbances now than we did in the
case of the taper tantrum. But, of course, as we continue to discuss and eventually
implement policies to reduce our balance sheet, we will have to continue to monitor
market developments and expectations carefully.
I would like to conclude by briefly discussing two issues. First, a question: Can
the Fed be too predictable? And, second, I will add a short comment on the SEP, the
quarterly Summary of Economic Projections of the participants in the FOMC.
With regard to whether the Fed can be too predictable, it is hard to argue that
predictability in our reaction to economic data could be anything but positive. To
reference the beginning of my talk, clarity about the Fed's reaction function allows
markets to anticipate Fed actions and smoothly adjust along with the path of policy.
But there is a circumstance where it might be reasonable to argue that the Fed
could be too predictable--in particular, if the path of policy is not appropriately
responsive to the incoming economic data and the implications for the economic outlook.
Standard monetary policy rules suggest that the policy rate should respond to the level of
economic variables such as the output gap and the inflation rate. As unexpected shocks
hit the economy, the target level of the federal funds rate should adjust in response to
those shocks as the FOMC adjusts the stance of policy to achieve its objectives. Indeed,
it is these unexpected economic shocks that give rise to the range of uncertainty around
the median federal funds rate projection of FOMC participants, represented through fan
charts, which was recently incorporated into the SEP. The Federal Reserve could be too
predictable if this type of fundamental uncertainty about the economy does not show
through to uncertainty about the monetary policy path, which could imply that the
Federal Reserve was not being sufficiently responsive to incoming data bearing on the
economic outlook.
Let me conclude with a few words on the SEP results as portrayed in the dot
plots. The SEP is a highly useful vehicle for providing information to market participants
and others for whom Fed actions are important. But we need to remind ourselves that the
SEP data for an individual show that person's judgment of the appropriate path of future
fed funds rates and the corresponding paths of other variables for which the SEP includes
forecasts.
Thus, one may say that the SEP shows the basis from which each participant in
the FOMC discussion is likely to start. But the task of moving from that information to
an interest rate decision is not simple and requires a great deal of analysis and back-and-
forth among FOMC participants at each meeting.
References
Bernanke, Ben S. (2004). "The Logic of Monetary Policy," speech delivered at the
National Economists Club, Washington, December 2,
https://www.federalreserve.gov/boarddocs/speeches/2004/20041202/default.htm.
-------- (2013a). "Communication and Monetary Policy," speech delivered at the
National Economists Club Annual Dinner, Herbert Stein Memorial Lecture,
Washington, November 19,
https://www.federalreserve.gov/newsevents/speech/bernanke20131119a.htm.
-------- (2013b). "Statement of Hon. Ben Bernanke, Chairman of the Board of Governors
of the Federal Reserve System, Washington, DC," in The Economic Outlook,
hearing before the Joint Economic Committee, Congress of the United States,
May 22, Senate Hearing 113-62, 113 Cong. Washington: Government Printing
Office,
https://www.gpo.gov/fdsys/pkg/CHRG-113shrg81472/pdf/CHRG113shrg81472.pdf.
-------- (2013c). "Transcript of Chairman Bernanke's Press Conference," June 19,
https://www.federalreserve.gov/mediacenter/files/fomcpresconf20130619.pdf.
Board of Governors of the Federal Reserve System (2017). "Minutes of the Federal Open
Market Committee, March 14-15, 2017," press release, April 5,
https://www.federalreserve.gov/newsevents/pressreleases/monetary20170405a.htm.
Shin, Hyun Song (2017). "How Much Should We Read into Shifts in Long-Dated
Yields?" speech delivered at the U.S. Monetary Policy Forum, New York,
March 3, https://www.bis.org/speeches/sp170303.htm.
Spicer, Jonathan (2017). "Fed Could Promptly Begin Shedding Bonds This Year:
Dudley," U.S. News, March 31,
http://money.usnews.com/investing/news/articles/2017-03-31/fed-could-begintrimming-bond-portfolio-this-year-dudley.
Stein, Jeremy C. (2014). "Challenges for Monetary Policy Communication," speech
delivered at the Money Marketeers of New York University, New York, May 6,
https://www.federalreserve.gov/newsevents/speech/stein20140506a.htm.
Woodford, Michael (2005). "Central Bank Communication and Policy Effectiveness," in
The Greenspan Era: Lessons for the Future, proceedings of a symposium
sponsored by the Federal Reserve Bank of Kansas City, held in Jackson Hole,
Wyo., Aug. 25-27. Kansas City, Mo.: Federal Reserve Bank of Kansas City,
pp. 399-474,
https://www.kansascityfed.org/publicat/sympos/2005/pdf/Woodford2005.pdf.
Monetary Policy Expectations and Surprises
Remarks by
Vice Chairman Stanley Fischer
Board of Governors of the Federal Reserve System
at the
School of International and Public Affairs
Columbia University
April 17, 2017
Figure 1: 10-Year Treasury Yields during the "Taper Tantrum"
Figure 2: Primary Dealer vs. Blue Chip Surveys
Point estimate for the most likely outcome of the level of the target federal funds rate or
range when the FOMC first announces a change to its reinvestment policy:
Primary Dealers: Market Participants:
Level of the Target Fed Level of the Target Fed
Funds Rate/Range Funds Rate/Range
25th Percentile 1.38% 25th Percentile 1.38%
Median 1.63% Median 1.63%
75th Percentile 1.88% 75th Percentile 1.63%
Percent chance you attach to the following outcomes for the level of the target fed funds rate
or range when the FOMC first announces a change in its reinvestment policy:
Primary Dealers:
≤ 0.75% 0.76 1.01 - 1.26 - 1.51 - 1.76 - ≥ 2.01%
1.00% 1.25% 1.50% 1.75% 2.00%
Average 0% 2% 13% 25% 28% 20% 12%
Market Participants:
≤ 0.75% 0.76 1.01 - 1.26 - 1.51 - 1.76 - ≥ 2.01%
1.00% 1.25% 1.50% 1.75% 2.00%
Average 0% 2% 12% 28% 32% 15% 11%
Indicate the percent chance you attach to the following possible outcomes for the timing of when the
FOMC first announces a change in its reinvestment policy:
Primary Dealers:
Mar. Q2 2017 Q3 2017 Q4 2017 Q1 2018 Q2 2018 H2 2018 ≥ 2019
1415 FOMC
Meeting
Average 0% 3% 8% 17% 21% 18% 19% 13%
Market Participants:
Mar. Q2 2017 Q3 2017 Q4 2017 Q1 2018 Q2 2018 H2 2018 ≥ 2019
1415 FOMC
Meeting
Average 1% 4% 11% 27% 21% 17% 10% 9%