Sunday, January 15, 2012

Fed's interest rate forecasts - will this help?

From its next meeting at the end of January, the Fed will replace its current guidance of exceptionally low interest rates “through mid-2013” with interest rate forecasts from each Fed policymaker for both the end of 2012 and the “next few calendar years” after that.

The Fed has announced that it will produce interest rate forecasts starting with the next Fed meeting. This is close to announcing an inflation target since nominal rates are just combination of real rates and expected inflation. However, there is more to this than just an surrogate inflation target. There will be a real component that this consistent with its dual policy mandate. It is true that the Fed has not been a good interest rate forecaster and they have not been able to target longer-term rates with any consistency so there is a danger here. The market may perceive they have more power than it actually has at meeting its forecasts. 

It will be interesting to see what they will do to actually reach or meet their forecasts. In fact, there is a key distinction between forecasts and targets. It is clarity between forecasts and targets which will be the most important information necessary for the markets. what happens if there is forecast error? How will the Fed adjust? These are issues that need to be addressed soon. It is not clear this will help the markets.

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