Can the Federal Reserve Please Shut Up?
The central bank’s faulty economic predictions hurt markets and the Fed’s own institutional credibility.
By Joseph C. Sternberg
Federal Reserve Chairman Jerome Powell quipped in a press conference last week that some of his colleagues wished they didn’t have to publish quarterly economic projections this month.
If only they’d heeded their instinct to keep quiet.
Mr. Powell was speaking, after the March Federal Open Market Committee meeting, of the forecast that committee members publish every three months about the possible course of economic growth, unemployment, inflation and interest rates.
This Summary of Economic Projections, or SEP, has become an important policy output of the Fed.
Investors and commentators scrutinize the tables and graphs—especially a runic “dot plot” of individual committee members’ guesses about future interest rates—for clues about the Fed’s thinking.
A SEP often moves markets the afternoon it’s released, and it sets a baseline against which investors judge subsequent policy decisions and statements from Fed officials.
The committee was uneasy about committing to such forecasts last week, Mr. Powell said, because the current environment is so uncertain.
No one can predict how long the Iran war will last, how it might affect global energy prices, and how it might filter through to the American economy.
Amid a similar fog in March 2020, the FOMC declined to publish quarterly projections in the early days of the pandemic.
Alas, Mr. Powell and his colleagues overcame their hesitation this time and we all got pelted with dots.
But look more closely and there are a lot of reasons beyond the Iran war why the Fed should call it quits on this exercise.
The Fed didn’t always nail its colors to a predictive mast.
Until the 1990s, the norm was near-total inscrutability from officials about their thought processes.
That changed under Alan Greenspan as officials began issuing somewhat more explanatory statements alongside their policy announcements.
This practice of overcommunicating, known as forward guidance, came into its own after the 2008 financial panic.
The Fed has accepted a theory that by “guiding” everyone’s expectations of future inflation and monetary policy, the central bank can affect inflation today.
Ben Bernanke was a particular advocate for the theory that Fed communications could serve as a policy lever in their own right, alongside manipulation of short-term interest rates and expansion of the Fed balance sheet.
By telling investors, businesses and households what monetary officials probably would do in the future, the Fed could steer behavior in the here and now.
With interest rates near zero at the time and quantitative easing already well under way, there wasn’t a lot else the Fed could do.
The dots were introduced in 2012 to signal that interest rates would remain low for an extended period.
With a new Fed chairman coming later this spring and renewed concerns about the central bank’s institutional independence, now is as good a time as any to ask whether this kind of forecasting helps the Fed or anyone else.
It doesn’t.
The Fed’s quarterly forecasting exercise is bad for the Fed’s credibility.
The most conspicuous feature of the SEPs in recent years is how wrong they’ve been.
Officials since 2022 have chronically goofed in predicting the pace at which they’d pull inflation down to their 2% target rate, exposing the technocrats’ faulty grasp of how the economy works.
Beyond an economic embarrassment, this is a political-economy nightmare.
The rationale for vesting awesome powers in a politically insulated central bank is that sage technocrats will make wise decisions.
The Fed undermines this premise four times a year by giving the public ample grounds to question officials’ sagacity.
This may go beyond an image problem.
An interesting research question for future generations of economics doctoral students would be whether publishing quarterly forecasts actually makes the Fed dumber.
The problem is the market response to the Fed’s policy guesses, and this month is illustrative.
Left to their own devices, investors might have spent Wednesday last week placing their bets about the economic consequences of the war.
Such signals might then have informed Fed policymakers about the true state of the economy.
Forward guidance in general, and the quarterly projections in particular, short-circuit this process by encouraging markets to recalibrate themselves not to events but to the central bank’s guesses about what it will do in the future.
Because forward guidance puts the Fed in the position of trying to steer markets rather than observing them, it necessarily risks obscuring important price signals policymakers would benefit from seeing.
This also exposes the Fed to complaints from elected politicians that it’s trying to influence markets in one direction or another for political purposes, even if it isn’t.
If ever there were a time for the Fed to shut up and listen, last week was it.
Consider this a plea to Kevin Warsh, nominated to succeed Mr. Powell as Fed chairman: Please, please, put the dots out of our misery.
Joseph C. Sternberg is a member of the Journal's editorial board and the Political Economics columnist. He joined the Journal in 2006 as an editorial writer in Hong Kong, where he also edited the Business Asia column. He is author of "The Theft of a Decade: How the Baby Boomers Stole the Millennials'
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