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US: Increased Fed transparency

Fri, Nov 16 2007, 17:45 GMT
by Peter Lildholdt

Danske Bank A/S

Overview: Yesterday, the Fed announced new steps for its communication policy:

- It will increase the frequency of FOMC forecasts for individual FOMC members to four times a year (from the present two)

- The forecast horizon has been extended to three years (from two)

- They will not adopt a formal inflation target (but the individual inflation projections at the three-year horizon can serve as informal inflation targets for each FOMC member)

- The first of these new projections will be released with the FOMC minutes on 20 November

- The current list of forecast variables (PCE core inflation, growth of real GDP, growth of nominal GDP, and unemployment) will be extended by headline PCE inflation. Nominal GDP growth will be deleted from the list.

Consequences: A higher publication frequency for the FOMC makes it possible for them to signal changes to the monetary policy outlook more frequently - and more directly. The extension of the forecast horizon from two to three years implies that the forecast to a larger extent will embed information on the FOMC members’ view on their inflation objective. The projections are made under the assumption of “appropriate” monetary policy, and the end point of the projections are therefore going to shed light on where FOMC members anticipate the forecast variables to revert to once all shocks have died out. The longer the forecast horizon, the more shocks will die out, and the more information about FOMC members’ implicit inflation target will be provided by the end point of the inflation projection. Of course, the projections will also shed light on the FOMC’s view on the potential growth rate and the natural unemployment rate of the US economy. It is important to emphasise, though, that a formal inflation targeting regime has not been adopted in the US. However, the new communication policy certainly moves in the direction of a formal inflation targetting regime.

Outlook: The minutes from the recent FOMC meeting are due for release on Tuesday 20 November. They are going to provide the first set of projections in line with the new communication policy. Apart from this, attention will primarily be focused on the considerations behind the neutral bias statement that was issued when the FOMC cut the Federal funds target by 25bp to 4.5% at the last meeting. We do not think that the minutes will provide significant news in addition to the information provided by Bernanke’s testimony last week, see “Flash Comment - US: A balanced Bernanke, but with a touch of unrest”.

Published on  Fri, Nov 16 2007, 17:47 GMT