The expectations of financial markets and economists for when the Federal Reserve will raise the federal funds rate are consistent with the Fed's own "forward guidance," according to research at the San Francisco Federal Reserve Bank released Monday.
Like a majority of Federal Reserve officials, Fed watchers and financial market players expect the first hike in the funds rate to come in 2015.
This parallelism is a good thing, San Francisco Fed research director Glenn Rudebusch and co-author Michael Bauer suggest, because it makes monetary policy more effective. If markets expected an earlier rate hike it would have a deleterious effect on the economy.
In its "forward guidance" on the path of the federal funds rate, the FOMC has stated, most recently on Oct. 30, that it expects to keep monetary policy "highly accommodative....for a considerable time after the asset purchase program ends and the economic recovery strengthens."
And the FOMC has said it will not consider raising the funds rate at least until the unemployment rate falls to 6.5%, so long as forecasted inflation is not above 2.5% and inflation expectations are "well-anchored."
Accompanying that guidance, in the FOMC's latest Survey of Economic Projections, released Sept. 18, 12 of 17 participants saw no hike in the funds rate until 2015.
It is important that public expectations of the date of the first funds rate hike not differ significantly from the FOMC's, the paper contends, because "changes in the expected liftoff date affect a wide range of current interest rates and financial conditions."
"These, in turn, alter household and business spending decisions and the
pace of economic growth," Rudebusch and Bauer write.
If the FOMC's communications "can help align the public's expectations of future policy with policymakers' views, then it may help monetary policy be more effective," they maintain. "Furthermore, this forward guidance is likely to be especially valuable now, when the federal funds rate is constrained by the zero lower bound."
To measure and compare public expectations with Fed expectations, the San Francisco Fed staffers look at surveys of business economists and forward market interest rates derived from the Treasury yield curve.
For instance, the paper notes, the September Blue Chip Economic Indicators survey foresaw the unemployment rate reaching the FOMC's 6.5% threshold in mid-2015. And the New York Fed's September primary dealers survey anticipated the first rate hike coming in the third quarter of 2015.
"Recent estimates of policy liftoff generally suggest the first funds rate hike will occur sometime in 2015," they write.
Similarly, interest rate futures, adjusted for the fact that the zero lower bound skews the results, imply the first rate hike will come in June 2015,Rudebusch and Bauer calculate.
They conclude, "Our estimates suggest that the FOMC's forward guidance has been effective in pushing out the expected liftoff horizon, which has contributed to lower interest rates, easing financial conditions and adding stimulus to the economy."
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