Academic journal article Economic Review - Federal Reserve Bank of Kansas City

Monetary Policy Transparency and Private Sector Forecasts: Evidence from Survey Data

Academic journal article Economic Review - Federal Reserve Bank of Kansas City

Monetary Policy Transparency and Private Sector Forecasts: Evidence from Survey Data

Article excerpt

In recent years, central banks around the world have greatly increased the monetary policy information they have provided the public. For example, many central banks have become more explicit about the longer-run objectives of monetary policy, such as long-run inflation objectives, and provided more detailed information about the monetary policy process. The Federal Reserve has taken a number of actions to promote transparency including, most recently, the announcement of enhancements to the FOMCs economic forecasts that are released to the public (Federal Open Market Committee).

The movement toward increased transparency arises largely from the view that increased transparency has important benefits, including more effective monetary policy. This view is based on theoretical and empirical research that has emphasized the importance of public expectations about monetary policy as a key factor in determining interest rates and other asset prices. In particular, this research suggests that improved predictability of monetary policy may reduce the volatility of asset prices and make monetary policy more effective by increasing a central bank's leverage over longer-term interest rates.

The view that policy transparency may increase the predictability of monetary policy has found considetable empirical support. A number of recent studies used information from federal funds futures, Treasury bills, and Eurodollar futures markets to show that financial markets in recent years have been better able to predict future policy actions over relatively short-run horizons, for example, from one to six months ahead. However, there are relatively few studies of predictability over longer-term horizons, for example, one or more years ahead. Longerhorizon predictability of policy actions is especially important because it helps derermine how much leverage central banks have over longerterm interest rates.

This article uses information from the Blue Chip Long Range Financial Forecasts to examine whether longer-horizon predictability has been associated with increased transparency. The Blue Chip survey, taken twice a year, asks a panel of forecasters to give their projections of interest rates over a ten-year horizon. Included in the survey are projections of the federal funds rate, which serves as the Federal Reserves principal operating target. Thus, the survey provides an estimate of the federal funds rate path over the next ten years. Comparing these forecasts of the federal funds rate with rhe actual federal funds rate allows us to judge whether private sector forecasts of monetary policy have improved as policy transparency has increased.

The analysis in this article suggests several interesting conclusions. First, consistent with results using futures data, there has been a marked reduction in survey forecast errors at short-term horizons - but less improvement at longer horizons. Second, to the extent private sector longer-horizon forecasts of future monetary policy have improved in recent years, most of the improvement occurred from 2003 to 2006, when the Federal Reserve provided more explicit guidance about the future path of the federal funds rate. During this period, forecast errors over all horizons dropped remarkably. Indeed, this period appears to have driven most of the improvement ?? the Blue Chip survey forecasts seen over the entire 1986-2007 sample period. Third, the survey evidence reported in this article does not support the finding of some studies that forecasting improved suddenly after 1994, Fourth, the longerhorizon forecast errors have been largest when policy was being actively tightened or eased, especially during the 1990-92 and 2001-03 periods of extended policy easing. Finally, longer-horizon forecast errors appear to have diminished during periods of tightening, but not during periods of easing.

The first section of this article provides a framework for discussing monetary policy transparency and how transparency is related to predictability of future monetary policy actions. …

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