Policy makers plan to abandon their promise to hold interest rates near zero at least as long as unemployment remains above 6.5 percent, according to minutes of their January meeting. With the jobless rate dropping to 6.6 percent and the economy still in need of support from the Fed, the strategy is nearly obsolete.
Now, the challenge for the policy-making Federal Open Market Committee is to move away from the unemployment threshold of 6.5 percent without raising expectations of an increase in the short-term interest rate. One option policy makers discussed last month is to rely instead on their forecasts for inflation, unemployment, growth and the benchmark interest rate — known as the Summary of Economic Projections — as a way to signal their policy intentions.
"I don't doubt the SEP will become even more important going forward," said Tom Porcelli, chief U.S. economist for RBC Capital Markets LLC in New York and a former analyst on the New York Fed's trading desk. "The Fed is really trying to give us as much information as possible, and that's kind of the great avenue to pursue."
Fed Chair Yellen took a leading role in conceiving how the central bank should use the forecasts as a communications tool. As former Chairman Ben S. Bernanke's top deputy, she ran a communications subcommittee that in 2012 overhauled the forecasts to include predictions for the path of the benchmark interest rate.
December 2008
The Fed's so-called forward guidance evolved after the central bank cut the main lending rate almost to zero in December 2008. At that meeting, Fed staff told policy makers that "it would be helpful for the committee to provide more- explicit information about its views on the likely future path of the federal funds rate," according to transcripts released last week.
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They did that initially by saying that the benchmark, the interest rate banks charge each other for overnight loans, would stay "exceptionally low" for "some time," or for "an extended period." That was later changed to guidance based on a specific date. Finally, in December 2012, the Fed linked the outlook for the benchmark rate to the level of unemployment and rate of inflation.
Labor slack
Unemployment in January fell to a five-year low of 6.6 percent, compared with 7.9 percent when the threshold was adopted. The trouble is that FOMC officials still see plenty of slack in labor markets, and inflation has consistently run below their 2 percent target since May 2012.
The committee has provided guidance not linked explicitly to its two policy goals of stable prices and full employment, and it will probably return to qualitative language once again, said Michael Gapen, New York-based senior U.S. economist at Barclays Plc.
The FOMC participants' own estimates for the policy rate could be a fallback.
In their December projections, 12 of 17 Fed officials estimated that the first increase in the benchmark lending rate would occur in 2015. The median forecast for that year was 0.75 percent, implying at least two increases during that year.
Using the forecasts as a guide to the rate outlook poses challenges. Because the Fed doesn't disclose the names of the forecasters, the median rate may not reflect the views of the voting members of the committee who decide on policy.
Voting membership
The voting membership is limited to 12 people: the seven members of the Washington-based Board of Governors along with five of 12 regional Fed bank presidents. The New York Fed chief has a permanent vote, and the others rotate.
The Fed could improve the SEP by identifying individuals by name, said Millan Mulraine, deputy head U.S. research and strategy at TD Securities LLC in New York, one of the 22 primary dealers authorized to trade directly with the Fed.
"If they are identified, I think we can get rid of some outliers and get a better sense of the core of the committee," said Mulraine. "It would provide a lot more transparency to the markets."
