(Bloomberg) -- For the past several months, Federal Reserve Chair Jerome Powell has hammered home the idea that interest-rate decisions will be made meeting by meeting based on incoming data.
The Fed publishes a summary of every policymaker’s quarterly economic forecasts, but Powell has referred to those as just a snapshot of views from that moment in time.
“The actual things that we do will depend on the way the economy evolves,” he said at his last press conference on Sept. 18.
This may sound logical, but in the world of monetary policy, it’s quite unusual.
Central banks always pay attention to incoming information about the economy, and during short periods of deep uncertainty, they’ll let that guide them station to station. But by carrying on this way for an extended period, Powell is beginning to rankle some investors and economists who say it’s time for him to show more conviction about what he expects from the economy over the coming year or so. That would help the public better understand where Fed policy is headed.
“Their data dependence is creating more volatility,” said Drew Matus, a strategist at MetLife Investment Management.
The quality of economic data has deteriorated and most is backward looking, Matus said. Also, data revisions can upend previous assumptions about the health and direction of the economy. “It is really not a great way to conduct policy,” he added.
With inflation settling down, Powell’s critics want him to tell a coherent, forward-looking story, and then to talk about the risks and big questions surrounding that outlook.
Feral Animal
The post-pandemic economy has been like a feral animal. Every time economists have tried to fence it in with an outlook, it’s leapt over estimates, often sprinting in a direction analysts didn’t expect. In 2021, officials and senior staff believed the spike in inflation would be “transitory.” It didn’t drop below 3% until November 2023. And following banking turmoil in early 2023, staff called for a recession. The economy grew that year by almost 3%.
“My sympathies are with Chair Powell,” said John Roberts, an adviser to Evercore ISI who spent decades at the Fed’s Board of Governors building and refining structural models of the US economy used in forecasting. “Don’t we call that being nimble?”
Still, decades of research suggest monetary policy works not only through where rates are set, but also where market participants and the public believe they’re likely to go over the next year or so, and a forecast is essential to that understanding. By contrast, focusing on the next couple of data releases keeps investors tethered to a six-week policy cycle.
“Every monetary economist knows that monetary policy works through the entire term structure, not just the current setting of the federal funds rate,” said Dartmouth College professor and former Fed economist Andrew Levin. Consequently, “the central bank needs to clearly explain how it will adjust the path of the federal funds rate if its baseline forecast turns out to be mistaken.”
Data Volatility
The last few labor market reports offer a lesson in the hazards of tight data dependence. July and August came in decidedly weak, so the Fed responded by starting its easing campaign with a big, half-point cut led by Powell.
Then job growth rebounded in September, and July and August were revised upward. The summer of weakness seemed to evaporate and traders rolled back bets on another big cut. Some economists have questioned whether the Fed panicked and acted too quickly.
Part of the problem is that the Fed doesn’t have a consensus forecast, but rather 19 individual forecasts that are published quarterly. Over time, chairs have embraced the Summary of Economic Projections, or SEP, or kept it at arm’s length depending on how useful it was to them.
“A forecast is better than not having a forecast because it disciplines the discussion,” said Adam Posen, president of the Peterson Institute for International Economics and a former member of the Bank of England’s policy committee. “If you don’t have a forecast, then the discussion is just about everybody’s feelings about what they think will happen next.”
Fed chairs do have a strong sense of how the committee sees the outlook. They speak with each FOMC participant before every policy gathering. And during the meeting, officials are typically very detailed and forward-looking, as was Powell when he was a governor, transcripts show. But those transcripts only become public with a five-year lag.
In his opening statement after the September meeting, Powell had a lot to say about current conditions and described how the Fed would respond to certain risks. He didn’t dwell on the medium-term outlook.
Gregory Daco, chief economist at EY, said Powell’s style is more about “openness to optionality” than forecast skepticism, and that’s somewhat unusual.
“He is really candid” about how the economy is evolving, Daco said. Nevertheless “a forward-looking perspective would be useful.”
Inflation targeting scholars such as Posen and former Fed Chair Ben Bernanke view a forecast as essential because it teaches the public, and financial markets, about why the central bank responds the way it does to new rounds of data.
“The regular publication of an economic forecast by the central bank has several communication functions,” Bernanke, now a distinguished senior fellow at the Brookings Institution, wrote in his review of the Bank of England’s forecasting methods this year.
It “provides the public with a broad rationale for the policy decision,” he said, and “helps to align private economic decisions and general financial conditions more broadly with the central bank’s view, which can make policy more effective in moving the economy in the desired direction.”
A solid, structured story about how the economy is expected to unfold also helps policymakers discuss risks to the outlook, says Claudia Sahm, chief economist at New Century Advisors.
“This is where a little more tightness on the story can help,” said Sahm. “If the base-case scenario doesn’t get well developed then the risks don’t get well developed either.”
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