Jerome H Powell: Discussion of the paper "Language after liftoff - Fed
communication away from the zero lower bound"
Speech by Mr Jerome H Powell, Member of the Board of Governors of the Federal Reserve
System, at the 2016 US Monetary Policy Forum, New York City, 26 February 2016.
* * *
The charts can be found at the Board of Governors of the Federal Reserve System's website.
The views expressed here are my own, and not those of the FOMC.
This paper reviews Federal Open Market Committee (FOMC) communications from the time
the Committee began issuing regular postmeeting statements in 1999 to the present.1 The
authors provide an extended and insightful discussion of the theory and practice of providing
forward guidance about monetary policy. They offer one central lesson: Data-based forward
guidance is mostly good, while time-based forward guidance is mostly bad.
The authors show that data-based guidance has desirable characteristics and can make
monetary policy more effective. When clearly articulated and well understood, it allows markets
to react appropriately to incoming data, doing the heavy lifting for the central bank.
Time-based guidance is found to have certain bad characteristics and should be avoided,
except at the zero lower bound and when other options are not available or not working.
Timebased guidance may reduce the sensitivity of rates to incoming macroeconomic data, suppress
volatility, encourage risk-taking and increased leverage, and threaten financial stability. It may
also put policymakers in a box when changes in the economy make it optimal to deviate from
previously expressed guidance, but the Committee cannot do so without losing credibility.
The authors blame time-based guidance for several episodes in which the Committee zigged
when the market looked for it to zag, leaving market participants unhappy and, in the authors'
view, the FOMC's credibility damaged. They argue that the Committee has relied too much on
time-based guidance in recent years and should use it only parsimoniously in the future.
I commend the authors for undertaking this enormously challenging and useful exercise. The
paper forces us to reconsider the Committee's evolving understanding of the macroeconomic
environment before, during, and after the Great Recession; its decisions and its
communications; and the market's understanding of those decisions, which have sometimes
deviated from what the Committee actually said.
The distinction between time-based and data-based guidance is an important one, and the
potential problems with time-based guidance are real and well described in the paper. That
said, I am not convinced that this distinction has played a central role in determining the
successes and challenges of FOMC communications in this remarkable era, or that it helps us
improve in the future. The authors are, in their words, "unabashedly judgmental" in labeling
specific communications to be either time- or data-based.2 My own judgments differ in
significant respects from those described in the paper.
Discussion of forward guidance
I will start in December 2008, when the Committee said that "weak economic conditions are
likely to warrant exceptionally low levels of the federal funds rate for some time."3 This relatively
weak time-based guidance was strengthened in a series of steps until August 2011, when the
time-based language became "at least through mid-2013."4 The calendar reference was later
extended in a couple of steps to "at least through mid-2015."5 This guidance was explicitly
time-based, and the authors seem to agree that, through this point, the guidance served its
intended purpose at the zero lower bound by pushing down medium- and longer-term rates.6
At the December 2012 meeting, the Committee ended this calendar-based guidance. The
Committee instead adopted thresholds, saying that it did not intend to raise rates at least as
long as unemployment remained above 6-1/2 percent, inflation one to two years ahead was
projected to be no higher than 2-1/2 percent, and longer-term inflation expectations remained
well anchored.7 The adoption of thresholds was a clear change to data-based guidance, as its
principal sponsors had frequently urged.8 The point was not to provide additional stimulus at
the time of adoption, but rather to allow market participants to adjust their expectations about
future monetary policy in response to incoming data - exactly what the authors advocate.9
The Committee also used balance sheet policy through most of this period. The first two
programs of large-scale asset purchases (LSAPs), popularly known as QE1 and QE2, and the
maturity extension program were announced in terms of time and quantity - that is, a certain
quantity of assets would be purchased over a certain time. In adopting QE3, by contrast, the
Committee committed to continuing purchases until there was a substantial improvement in
the outlook for the labor market.10 QE3 was fully data-contingent.
3
Board of Governors of the Federal Reserve System (2008), "FOMC Statement and Board Approval of Discount
Rate Requests of the Federal Reserve Banks of New York, Cleveland, Richmond, Atlanta, Minneapolis, and
San Francisco," press release, December 16, paragraph 4.
4
Board of Governors of the Federal Reserve System (2011), "FOMC Statement," press release, August 9,
paragraph 3.
5
Board of Governors of the Federal Reserve System (2012), "Federal Reserve Issues FOMC Statement," press
release, September 13, paragraph 5.
6
Some viewed this guidance as merely a forecast of Committee action, designed to better inform the market and
reduce uncertainty. Others have argued that such guidance is understood as a promise to which the Committee
will be held irrespective of future macroeconomic developments. The Committee never offered a single
explanation, and participants may have had different views. Engen, Laubach, and Reifschneider (2015) argue
that the Federal Reserve's time-based guidance initiated in August 2011 was highly effective in inducing market
participants to change their beliefs about the Committee's reaction function and to regard monetary policy as
more accommodative. Using Blue Chip survey data, the authors estimate that the perceived weight on resource
slack roughly doubled between March 2011 and March 2012. In an August 2011 speech, Chairman Bernanke
indicated that the guidance about the federal funds rate path was highly conditional on the outlook, saying, "in
what the Committee judges to be the most likely scenarios for resource utilization and inflation in the medium
term, the target for the federal funds rate would be held at its current low levels for at least two more years."
(Ben S. Bernanke (2011), "The Near- and Longer-Term Prospects for the U.S. Economy," a speech delivered
at "Achieving Maximum Long-Run Growth (PDF)," a symposium sponsored by the Federal Reserve Bank of
Kansas City, held in Jackson Hole, Wyo., August 26, p. 7.)
7
Board of Governors of the Federal Reserve System (2012), "Federal Reserve Issues FOMC Statement," press
release, December 12, paragraph 5.
8
For example, see Charles L. Evans (2012), "Macroeconomic Effects of FOMC Forward Guidance," speech
delivered at the Spring Panel on Economic Activity, Brookings Institution, Washington, March 22; and Alejandro
Justiniano, Charles L. Evans, Jeffrey R. Campbell, and Jonas D.M. Fisher (2012), "Macroeconomic Effects of
FOMC Forward Guidance (PDF)," Brookings Papers on Economic Activity, Spring, pp. 1-54.
9
The thresholds' useful life was fairly short because the unemployment rate fell sharply, from 8.0 percent in
December 2012 to 6.2 percent in April 2014, while inflation remained below 2.0 percent.
10
The December 2012 FOMC statement indicated that, "If the outlook for the labor market does not improve
substantially, the Committee will continue its purchases of Treasury and agency mortgage-backed securities,
Former Chairman Bernanke recounts in his recent book that he saw QE3 as akin to Mario
Draghi's statement that the European Central Bank would do "whatever it takes."11 He also
notes that FOMC participants held divergent views on the potential costs and benefits of the
program. Minutes of the relevant meetings described the complex discussions and differing
views. Contemporaneous reports by Wall Street analysts show frustration and confusion about
the Committee's intentions.
When various FOMC communications suggested that the time to begin reducing purchases
was nearing, long-term rates rose sharply - the so-called taper tantrum. The contention of this
paper is that time-based guidance was responsible. But as the paper acknowledges, the
openended, data-contingent nature of the QE3 program created a strong sense that the Fed was
"all in" and that the purchases might go on for a long time. That powerful commitment "would
set things up for some fireworks" when the time came to provide more precise guidance as to
the timing of tapering, whether that was done through time- or data-based guidance.12 While
Committee communications are subject to fair criticism, I don't see an important role in this
narrative for time-based guidance.
Let's turn briefly to 2015 and the run-up to last December's increase in the federal funds rate
- also an important focus of the paper. The authors and many market participants are critical
of communication around the September meeting. With the June 2015 Summary of Economic
Projections (SEP) showing that 15 of 17 FOMC participants judged that appropriate policy
would entail an initial increase in the federal funds rate by the end of 2015, markets saw about
a 50 percent chance that the first increase would occur in September. This probability fell to
about 30 percent after global markets experienced a sudden bout of volatility following China's
surprise devaluation of its currency in August. At the September meeting, the FOMC decided
to wait to see how global markets and the economy evolved, noting in its statement that
"Recent global economic and financial developments may restrain economic activity somewhat
and are likely to put further downward pressure on inflation in the near term."13
A data-driven Committee, making decisions meeting by meeting, is likely to surprise markets
from time to time. The authors join many others in criticizing the "measured pace" period of
2004 through 2006, during which the Committee increased rates by 25 basis points at
17 consecutive FOMC meetings. A common criticism has been that this high level of
predictability made investors complacent, encouraging a buildup of leverage and helping set
the stage for the Global Financial Crisis. That criticism may well overstate the importance of
the Committee's communications; nonetheless, a number of FOMC participants have said that
the Committee intends to be "data driven" and not fall into an excessively predictable,
datainsensitive path. Lower predictability implies more surprises.
In the statement released after its October 2015 meeting, the Committee reemphasized data
dependence and focused on the importance of incoming data for the Committee's decision "at
its next meeting," which led the market to increase its estimated probability of a December rate
increase from 38 percent to 50 percent.14 The October and November non-farm payroll reports
came in strong and above expectations, raising that probability by the time of the December
meeting to about 90 percent. In other words, the Committee used modest time-based guidance
to set the stage and then let incoming data do the heavy lifting. In the statement released after
the FOMC's most recent meeting in January, the Committee said that, in evaluating future
adjustments to the target range for the federal funds rate, it would "assess realized and
expected economic conditions relative to its objectives of maximum employment and 2 percent
15
inflation."15 This language shows that the Committee has moved away from the time-based
guidance of the crisis years.
Although time-based guidance can create communications challenges, I see other factors as
having been more important in recent years. In particular, the challenge of deciding when and
how to use unconventional tools - and ultimately when and how to reduce that usage - is a
great one. The task of communicating clearly about those decisions is equally great. And the
reality of the FOMC's size and diversity, not to mention uncertainty about the evolving structure
of the economy and the effects of monetary policy actions, means that we are still far from the
ideal world of a fully worked out, clearly specified and transparent consensus on what
economists call a "reaction function" - a complete description of how policy will respond to
changes in economic conditions.
Often when communicating about the path of policy, it will be hard to avoid a combination of
the two forms of guidance. For example, the Committee has embraced the view that the
equilibrium level of the federal funds rate is currently below its pre-crisis level and expects the
funds rate to return only gradually to its longer-run value.16 This view is a key aspect of many
Committee participants' reaction functions, including mine. Try saying that without referring to
time.
The authors acknowledge that the distinction between rules and discretion is too simple to
capture the problems that monetary policymakers face.17 I would say the same of the
distinction between time-based and data-based forward guidance.
Lessons learned and suggested improvements
Before turning to the paper's conclusions, I would like to put the Federal Reserve's
communications into a broader context. In recent years, the FOMC has adopted many new
and significant communications tools. Since the fall of 2007, policymakers have submitted
projections in conjunction with four FOMC meetings each year; in 2012, those projections were
augmented to include each participant's path for appropriate monetary policy. In 2011, the
Chairman began holding quarterly press conferences. In 2012, the Committee first released
its statement on Longer-run Goals and Monetary Policy Strategy, which formalized the
FOMC's 2 percent inflation objective and is reaffirmed each year at the January meeting.
14
Board of Governors of the Federal Reserve System (2015), "Federal Reserve Issues FOMC Statement," press
release, October 28, paragraph 3.
15
Board of Governors of the Federal Reserve System (2016), "Federal Reserve Issues FOMC Statement," press
release, January 27, paragraph 4.
16
For example, the January 2016 FOMC statement says, "The Committee expects that economic conditions will
evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is
likely to remain, for some time, below levels that are expected to prevail in the longer run." (Board of Governors
of the Federal Reserve System (2016), "Federal Reserve Issues FOMC Statement," press release, January 27,
paragraph 4.)
17
Feroli and others, "Language after Liftoff," in note 1, p. 11; and Ben S. Bernanke and Frederic S. Mishkin (1997),
"Inflation Targeting: A New Framework for Monetary Policy?" Journal of Economic Perspectives, vol. 11
(Spring), pp. 97-116.
These and other changes have kept the Federal Reserve among the world's most transparent
central banks in its communications with the public.
With that as background, I find significant grounds for agreement and further analysis in the
paper's concluding section, which lays out lessons learned and suggested improvements. The
discussion of what is colloquially known as the "dot plot" included in the SEP is particularly
interesting. The dot plot represents each FOMC participant's individual assessment of the path
of the federal funds rate over the next three years that is most likely to promote maximum
employment and stable prices.18
The dot plot presents a number of challenges. The individual dots are not tied to the individual
macroeconomic forecasts presented in the SEP, and no information is provided on the identity
of the forecaster - for example, voting members of the Committee are not distinguished from
non-voting participants. There is no easy path to the identification of a Committee reaction
function. The dots speak as of their date of publication after the FOMC meetings held in March,
June, September, and December. Three months pass between SEPs. The economic outlook
can change quite significantly, making the reigning dots look out of touch. On occasion, the
dot plot and the postmeeting statement have seemed to send conflicting signals. The dot plot
reflects individual views of appropriate policy, while the postmeeting statement reflects the
consensus of the Committee.
The authors weigh these challenges and ponder whether to eliminate the dot plot; some appear
to favor that idea.19 I doubt that most market participants would welcome the elimination of this
chart. The SEP provides a number of benefits. It requires FOMC participants to write down
their forecasts for inflation, unemployment, and growth, as well as their assessments of
appropriate monetary policy. This exercise helps policymakers to be more systematic. In
addition, by observing how the SEP changes over time, the public can better understand how
Committee members react to changes in the economy. My view is that the dot plot, on balance,
is helpful to market participants and hence to the Committee. As the dot plot enters its fifth
year of existence, my hope is that we will be able to capture those benefits while avoiding its
shortcomings.
I agree with the paper's suggestion of greater emphasis on the degree of uncertainty around
the projections, which is much larger than the dispersion of the individual forecasts. As you
know, at its January meeting, the Committee discussed adding fan charts to the SEP. Fan
charts could help emphasize that the economic outlook is uncertain, and that consequently
there is considerable uncertainty around the path of policy.