ON THE INFORMATION CONTENT OF ASYMMETRIC FOMC POLICY STATEMENTS: EVIDENCE FROM A TAYLOR-RULE PERSPECTIVE

I. INTRODUCTION Since 1983, the Federal Open Market Committee (FOMC) has included in its policy directives a statement indicating conditional expectations about the future. Although the specific language used to communicate expectations has evolved over the years, the "bias" statement has persistently been interpreted as an indicator of the likely direction of future changes in the committee's Federal funds rate target and has therefore been carefully monitored by Fed watchers and other financial market participants. As the FOMC has enhanced its efforts to communicate its policy intentions to the public in recent years, the contemporary version of the bias statement has been subject to considerable discussion and scrutiny. From 2000 through 2002, the FOMC's postmeeting press releases included a statement referring to the "balance of risks" in the "foreseeable future." Paralleling the Federal Reserve's dual objectives of price stability and maximum sustainable economic growth, the statements took the form of stating that the concerns of FOMC members about prospective economic developments are tilted toward either "inflation pressures" or "economic weakness." In 2003, the committee expanded this "balance of risks" language further to identify separate risk assessments for both inflation and real economic activity. When it was adopted, the language of the balance-of-risks statement was intended to be more general than the previous statements of policy bias, to avoid giving the impression that the statements directly signaled impending changes in the funds rate target. Nevertheless, as was the case with the earlier language--the balance of risks statement has tended to be interpreted as indicating likely future policy moves. In this article, I examine the question of whether such an interpretation might be warranted as an empirical matter. In particular, I examine the information content of asymmetric policy statements for predicting future FOMC policy actions using monthly dummy variables to indicate the prevailing direction of policy asymmetry over a sample period of 1984-2002. The time-series approach facilitates the use of a monthly data set for conditioning the information content of the bias statement on macroeconomic variables thought to be of importance to policy makers. In particular, I use inflation and output data to estimate a baseline Taylor-rule specification for policy and test whether the bias statement provides any additional information for forecasting changes in the FOMC's Federal funds rate target. The evidence presented here shows that the statements of policy asymmetry do indeed convey information that is useful for forecasting changes in the funds rate target. The information content in the bias statement has been a statistically significant factor for predicting changes in the funds rate target over the sample period, even after controlling for responses to policy variables in the Taylor-rule equation. In light of this finding, I estimate an alternative specification in which the variables representing asymmetry are interacted with the parameters of the estimated Taylor-rule equation. From this perspective, statements of policy bias are associated with a greater or lesser degree of responsiveness to inflation and output data. During the sample period considered here, variation in the committee's responses to inflation data has evidently been the predominant factor for explaining the predictive power of asymmetric policy statements. This is particularly true for the first half of the sample period, in which the FOMC was actively pursuing a policy of disinflation. II. THE ASYMMETRIC POLICY STATEMENT AND ITS INTERPRETATION A Brief History From 1983 until 1997 statements of an asymmetric bias were included in the FOMC Policy Directive, as a note that "greater reserve restraint" or "lesser reserve restraint" either "would" or "might" be acceptable during the intermeeting period, depending on emerging economic circumstances. …