U.S. Federal Reserve officials will begin publishing their forecasts for interest rates this month, a historic shift in strategy that central bankers hope will encourage more investment and spending.
The Federal Open Market Committee, the body that determines Fed policy, will reveal its rate projections for the fourth quarter of 2012 as well as for the next few years and the longer term, according to the minutes of the FOMC’s December meeting released on Tuesday.
The decision represents a break from the Fed’s long-standing belief that monetary policy is strengthened by retaining the element of surprise. Alan Greenspan, Fed chairman Ben Bernanke’s immediate predecessor, believed that making targets public would reduce the Fed’s ability to react to changes in the economy and financial markets.
But Mr. Greenspan’s view was formed in an era when monetary policy usually amounted to little more than controlling inflation by raising and lowering the benchmark interest rate.
Central banking is different now. The Fed’s target interest rate has been set near zero for three years and it twice has sought to lower borrowing costs by creating hundreds of billions of dollars to purchase financial assets, a strategy commonly referred to as quantitative easing. The problem for the Fed is this new reality is a confusing one.
Households, executives and investors have proved reluctant to borrow and invest, even though credit rarely has been cheaper. The Fed is betting that enhanced clarity about where interest rates are headed will bolster confidence and boost economic growth.
The interest rate guidance will be included with the quarterly economic updates of FOMC members, which the Fed publishes as the Summary of Economic Projections. The next update is scheduled for release after a two-day meeting that ends Jan. 25.
Mr. Bernanke has favoured more transparency since he first joined the Fed as a governor in 2002. He is finally getting his way because the central bank is struggling to breathe life into the economy. More than two years after the recession ended, the unemployment rate is at 8.6 per cent and growth is sluggish, even though corporate profits reached record levels in 2011.
The Fed’s list of worries is a long one. Policy makers in December described economic growth as “moderate,” and implied that most members of the policy committee believe it will remain that way because of the European debt crisis, weaker demand for exports, government spending cuts, “high levels” of uncertainty among businesses and consumers, the stagnant housing market and a desire by households to pay off debt.
“A number of members indicated that current and prospective economic conditions could well warrant additional policy accommodation, but they believed that any additional actions would be more effective if accompanied by enhanced communication about the committee’s longer-run economic goals and policy framework,” the December minutes said.
The Institute for Supply Management said Tuesday that its index of factory production rose to 53.9 in December, the highest in six months and a level that is consistent with economic growth at an annual rate of 4 per cent.
Similar reports reached similar conclusions in other major economies, including Canada. Yet few economists budged from their projections that economic growth will slow as 2012 wears on. Economists at Bank of Nova Scotia in Toronto published forecasts that said the U.S. economy would do well to grow 2 per cent this year. Bank of America Merrill Lynch said Tuesday that there is a 40-per-cent chance the U.S. will have a recession.
“The data is coming in better than expected, but the numbers aren’t particularly robust,” Craig Wright, chief economist at Royal Bank of Canada, said from Toronto. This year is “going to feel a lot like last year,” when things looked good early, yet U.S. gross domestic product barely grew in the first half, Mr. Wright said.
Economists welcomed the Fed’s embrace of transparency, but were skeptical the strategy would do much to alter the course of the economy. Some members of the FOMC also questioned the usefulness of the new communications plan, the minutes show.
Last summer, the Fed took a step toward transparency by stating that it would leave interest rates exceptionally low until at least the middle of 2013. That guidance will become even more explicit, as FOMC members also will release their estimates of when interest rates will rise. The forecasts will be reinforced by a “narrative” explaining the thinking behind the projections.
Finally, the Fed will issue a statement on its longer run goals and policy strategy. That’s a lot of information, and analysts predicted short-term confusion on the way to eventual transparency.