The Fed's new communication strategy: is it stealth inflation targeting? Or is it simply enhanced transparency?

Business Economics, July, 2008 by Michael Woodford

Could a similar approach be adopted by the Federal Reserve? The FOMC is already publishing a summary of the FOMC members' forecasts for several other variables. And these forecasts are supposed to be made under each member's assessment of "appropriate monetary policy." Conceptually, at least, it would be a relatively small step to ask each member to describe his or her projected path for the federal funds rate under the assumption of "appropriate monetary policy," as well as the other variables. If, for example, such a procedure had already been in place in the summer of 2003, the publication of projections indicating a substantial degree of unanimity among FOMC members about the judgment that the funds rate would remain at or near one percent through the following summer would have achieved the same end as the commitment to "a considerable period" of accommodation--and it would likely have been even more effective, as a consequence of its greater precision.

Would this run the risk of requiring FOMC members to commit themselves far in advance to particular interest-rate decisions? I think it could be done in a way that would create little expectation of that kind. Stressing the conditionality of the projections on data available at the time would be important; and, over time, as the discussion of reasons for each meeting's projections to differ from those made at the previous meeting become a routine part of each "Summary of Economic Projections," this should become well understood by readers of the summary. Moreover, allowing for changes in policy in response to developments that could not previously be forecasted is as much flexibility as any committee member should seek. In fact, advance commitment of policy, to the extent that things work out in the way that had previously been anticipated, should lead to superior policy decisions, as an advance decision of this kind leads the policymaker to internalize the consequences of policy anticipations.

The risks of misunderstanding would also be reduced if policymakers announced confidence intervals for their projections rather than point forecasts. This is a weakness of the format currently used for the FOMC's "Survey of Economic Projections," which emphasizes the distribution of views across committee members, but not the degree of uncertainty associated with each of these forecasts. The current questionnaire does, however, solicit rough assessments of uncertainty from each member, and this could be extended and used to present the forecasts in a way that further emphasized their uncertainty.

Even more to the point would be to clarify the contingency of the projections by providing more information about the kind of possible future developments that should be expected to affect future policy. To some extent, this can be achieved by explaining the general framework within which policy decisions are made--something that forecast-targeting central banks say a good deal about, though the Fed's "enhanced" communication strategy still seeks to avoid any explicit statements about this, as I discussed above.