The Fed's New Approach: Does It Matter?

by: Robert Brusca

In all my years of Fed watching one thing you never did was to ask any Fed official about interest rates. Now the Fed is going to present us with interest rate forecasts. How valuable are these projections? Is the Fed giving away the crown jewels?

Probably not. I don't think I'm going to need a new day-job.

The Fed no longer operates with targets. It now has a real dual mandate. That means we really never know what the Fed's real objective is. We are told that the Fed's 'long run' projections represent its desired values for the variables that it forecasts like GDP growth, unemployment and inflation. But so what? When you have multiple objectives the real issue is which one are you really going to pursue? What do you do when there is a conflict? If we don't know that, then having multiple guidelines tells us nothing. A guideline is not a target. When a central bank has a target it puts its credibility on the line. Missing a target has repercussions. But with multiple guidelines, missing one means nothing. Nothing at all. So now we have more of them.

What does it mean to get Fed forecasts of GDP, unemployment, inflation and then to put interest rates in the forecast mix? It is beginning to look like information overload. It is so much forecasting that nothing means anything.

I want the Fed to tell me the one thing it wants. Then I will know something.

Fed interest rate forecasts tell us what the Fed members think as of today. But as of tomorrow the information we have changes and each day that passes the situation changes a bit more, and who knows how the Fed members will change their idea of policy as time passes and economic circumstances change? That's why its forecasts are less than useful. They are perishable.

This is why periodic Fed FOMC member interest rate projections are not game-changers. As we await the Fed's first such release there is a lot of anticipation and there is some concern that the bond or foreign exchange markets will react to the results. There may be a trading opportunity for someone in the immediate aftermath of the release. But I doubt it will be of the Fed's making.

I would be much happier to know how the Fed thinks than to know what it thinks. The Fed in the name of transparency is telling us more and more and yet communicating to us less and less. When the Fed had strict money supply targets we knew something. We knew how the Fed would react if money growth were to become too weak or too strong regardless of what the Fed's forecasts were- regardless of them… Now we have more information on Fed forecasts but less information on how the Fed thinks. The dual mandate is a quagmire of inconsistency. It says that the Fed wants to have its cake and eat it too. But what if it can't? There is no push comes to shove with the dual mandate. The Fed simply wants it all. Fed forecasts give us no insight at all into the Fed's reaction function. We don't know how the Fed will react in an unexpected future. We don't really know what the Fed values most.

If we look historically at the FOMC's ability to forecast it has not been very good. So why should the FOMC's interest rate projections be any better? Add to that their perishability and you can see why I am disdainful of this as communication or as a useful policy move.

I want to know how the Fed thinks that the economy works. I want to know why the Fed gave up its successful Volcker/Greenspan strategy of getting inflation right first, arguing that when inflation was low the Fed did the best it could for growth. I want to know why Bernanke backtracked on what has been a successful monetary framework that has been in place for 30-years? Why Ben? Why did he switch from the inflation-first to the dual mandate view? Was there some agreement to push a more pro-growth agenda for the Congress in return for the Fed keeping tis regulatory authority? Why would the Fed want to be put in a position where some of the 'monetary policy' actions it is taking look more like fiscal policy? This tilt has only gotten the Fed into more trouble and criticism.

I have lots of unanswered questions. But what I also have is a Fed that on balance is much less transparent in 2012 than it was from Oct 1979 to late 1982, when the Fed published monetary targets that meant something. Then, it communicated to us. If it had a real inflation target it would communicate to us much better today. But having no targets and a slew of guidelines and offering up a bunch of forecasts, the Fed is pandering to the idea of transparency. It's like the Fed set up a committee whose mandate was to decide, "What can we tell them to get them off our back?" I'd prefer some real discourse. I'd like to know what the Fed really thinks. I'd like to know what it holds dear. So look ahead to this week's Fed reports if you like. But don't hold your breath for something big. It's just not there.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.