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

Business Economics, July, 2008 by Michael Woodford

8. Discussion of Alternative Scenarios

I believe that it would also be useful to illustrate the general policy strategy by talking through particular alternative scenarios and how the FOMC would expect to respond should they occur. The questionnaire used to solicit the forecasts of FOMC members could be expanded to ask them to comment on a small number of alternative scenarios and not simply on their view of the most likely evolution given current knowledge. In fact, since the board staff currently prepares its own projections under several alternative scenarios and circulates these for discussion prior to each meeting, it would only be necessary to solicit the FOMC members' views of the scenarios that they are already asked to consider. A summary of views of appropriate policy under each of the scenarios could then be included in the "Summary of Economic Projections" in the published minutes of the FOMC meeting.

Extension of the "enhanced projections" under alternative scenarios would improve the private sector's ability to predict Fed policy for at least three reasons. First, it should make FOMC members more comfortable talking about the interest rate paths associated with their projections by making it clear that several scenarios are possible. Second, discussion of multiple scenarios should also help people in the private sector understand how the outlook for policy could be affected by at least some of the kinds of news that may arrive between publications of the projections. Third, at the same time, discussion of the appropriate response to alternative scenarios should also help to clarify the nature of the FOMC's longer-run policy objectives for the FOMC members themselves. Thus, the use of scenarios should also serve the purpose of stabilizing medium-to-longer run expectations. One hopes that an evolution of the policy along lines of this sort will be considered by the FOMC as it gains further experience with its new communications policy.

(1) See, for example, Bernanke et al. (1999), which includes a chapter arguing that inflation targeting would be desirable for the United States.

(2) For evidence that the inflation reports of forecast-targeting central banks do actually increase the predictability of policy, see Fracasso et al. (2003).

(3) It is no accident that the Bank of England was finally granted the authority to set interest rates independently in 1997, after several years of experience with a forecast-targeting regime.

(4) For further discussion, see Woodford (2007).

(5) A partial exception is Norway, where the official target criterion requires that the projections maintain "a reasonable balance" between the gap between actual and target inflation, on the one hand, and the rate of "capacity utilization" on the other. However, even in this case, greater prominence is given to the requirement that the inflation rate be projected to converge to the target rate. See the box, "Criteria for an appropriate interest-rate path," in Norges Bank Monetary Policy Report 2007/3, p. 9.