Magazine article Regional Economist

What Does Data Dependence Mean?

Magazine article Regional Economist

What Does Data Dependence Mean?

Article excerpt

The Federal Open Market Committee (FOMC) has emphasized that decisions regarding the normalization of monetary policy will be data-dependent. Data dependency is sometimes misinterpreted as meaning decisions are based on the data released just before an FOMC meeting. That interpretation is far too narrow and inconsistent with good monetary policymaking. Rather, the decisions should be based not only on the current dynamics in the data but also on longer-run trends and expectations for data going forward.

Data are often revised, sometimes significantly. For example, payroll employment increased in August 2014 by an initial estimate of 142,000 compared with the current estimate of 213,000.1 Knowing that revisions are possible, monetary policymakers must strike a balance between not wanting to react too much to day-to-day observations on the economy versus wanting to react sufficiently to changes in underlying macroeconomic conditions. Every observation on the economy (e.g., a GDP report or an employment report) contains a certain amount of signal and a certain amount of noise. The art of policymaking includes separating the signal from the noise.

Weather is a factor that at times can increase the size of noise relative to the signal for economic data. In such cases, monetary policymakers might want to temper their reaction to specific data. Consider the case of real gross domestic product early last year, when weather was thought to have disrupted economic activity. According to the most recent estimate, real GDP in the first quarter of 2015 grew at an annualized rate of 0.6 percent-higher than the initial and follow-on estimates of 0.2 percent, -0.7 percent and -0.2 percent. The FOMC did not make any appreciable adjustments to policy in response to those GDP reports. As this example illustrates, data dependence does not mean necessarily that a particular number or even a sequence of numbers is going to change the course of policy.

Monetary policy decisions must be made with an eye toward the future. It is well-known that monetary policy operates with long and variable lags. Accordingly, the monetary policymaker must incorporate forecasted future outcomes when making current monetary policy decisions. Although macroeconomic forecasts are changed in response to new data, the changes tend to depend on whether a particular piece of data was expected and how important it is relative to other pieces of data. Given that the contours of forecasts do not change very quickly, monetary policy strategy also does not change very quickly. However, both probably would change in response to an ongoing slew of worse-thanexpected or better-than-expected data. …

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