The Federal Reserve has further increased its transparency over the last couple of years. In 2007, for example, the Federal Open Market Committee (FOMC) introduced the Survey of Economic Projections (SEP), which reports Committee participants' projections for GDP growth, unemployment, and inflation. In January of 2012, the projections were expanded to include the federal funds rate. These projections are based on each participant's view of appropriate monetary policy.
The inclusion of interest rate projections allows a rare opportunity to see whether a simple "guide post" might accurately describe participants' views on appropriate policy. Monetary policy is frequently discussed in terms of guideposts, and often these are presented in the form of Taylor-type rules.
Appropriate timing of policy firming
Number of participants
January projections April projections
2012 3 3
2013 3 3
2014 5 7
2015 4 4
Source: Federal Reserve Board.
Note: Table made from bar graph.
The original Taylor rule posited that the current federal funds rate is set as a function of the long-run interest rate, deviations of inflation from the FOMC's target (currently 2 percent), and deviations of economic output from its potential. One common modification of this rule, which is more consistent with the Committee's dual mandate of promoting price stability and maximum employment, is to look at deviations of unemployment from long-run unemployment instead of GDP from its potential. Until interest rates hit near-zero and could not be lowered any further, this rule tracked the actual funds rate fairly closely.
We look at how this rule lines up with the Committee's statement that the current extraordinary monetary policy accommodation will continue until late 2014. Since the Committee's statement reflects the consensus opinion, we will also see how well the rule does in describing the entire distribution of Committee members' interest rate projections, reported in the SEP.
First let us summarize the FOMC participants' stated views. In both January and April, the Committee's statement said "economic conditions are likely to warrant exceptionally low levels of the federal funds rate at least through late 2014." Similarly, in the SEP released after those meetings, the median Committee member set the time for leaving the zero lower bound--"liftoff"--somewhere during that year. While two participants expected this hike to occur in 2016 at the January meeting, by April there were no participants expecting the hike to occur that late.
Looking at individual projections for real economic variables, we see that in April, FOMC participants were expecting lower unemployment and higher inflation in the short term than they were in January. Yet by 2014, the forecasts are largely unchanged.
Next, we use the economic projections from the January and April SEP to produce a federal funds rate path into the future using the Taylor rule discussed earlier. We then compare the federal funds rate path implied by the Taylor rule to the liftoff dates implied by participants' interest rate projections.
We assume that the Committee participant predicting the earliest hike in the interest rate has the highest long-term interest rate projections, the lowest unemployment projections, the highest long-run unemployment rate projections, and the highest inflation projections. This is necessary since we do not have the data to map which inflation rate goes with which unemployment rate, interest rate, etc. We do this for the upper and lower ranges, the upper and lowest central tendency of the projections (which excludes the three highest and three lowest projections for each variable in each year), and the median path or the midpoint of the projections. …