With monetary policy near the bottom of the range of Federal Open Market Committee estimates of its longer-run neutral rate, communications will need to change, Federal Reserve Bank of Cleveland President Loretta Mester said Tuesday.
“Our monetary policy communications are also transitioning with less emphasis on forward guidance about future interest rate moves and more focus on the economic and financial information that affects our medium-run outlook and on how policy is likely to respond to changes in the outlook and risks,” Mester said in a speech in Delaware, according to prepared text released by the Fed.
Calling it “a year of transitions,” Mester said she sees the economy transitioning “toward a more sustainable pace of growth, with continued strength in labor markets and inflation near 2%,” although several risks exist “including the slowdown in global growth, uncertainty over trade policy, tighter financial conditions, and the changes in business and consumer sentiment.”
In recent years, “policy decisions were fairly straightforward,” but now there’s more uncertainty. “The reduction in accommodation has brought our policy rate to the lower end of the range of FOMC participants’ estimates of its longer-run neutral rate, although there is uncertainty around the exact level of the policy rate that is consistent with a neutral stance,” she noted. “In addition, our most recent policy rate increases are still working themselves through the economy, and we are gradually reducing the longer-term assets on our balance sheet, which likely is putting some upward pressure on term premia and, therefore, on longer-term interest rates.”
With policy not “far behind or far ahead of the curve,” the Fed has the opportunity to continue to gather information on the economy and assess our medium-run forecast and the risks around that forecast, before making any further adjustments in the policy rate.”
Based on her expectations, the fed funds rate target “may need to move a bit higher than current levels,” she said. “But if some of the downside risks to the forecast manifest themselves, and the economy turns out to be weaker than expected and jeopardizes our dual mandate goals, I will need to adjust my outlook and policy views. So the economy is going to give us a good sense of whether policy is where it needs to be or whether further action is needed.”
As for communications, Mester said it’s important that the message is clear. “Clear communications also make monetary policy more effective,” she said. “When households, businesses, and investors have a better sense of how monetary policy is likely to change conditional on the outlook, they can make better economic and financial decisions.”
Forward guidance was a great help in responding to the Great Recession, she noted. “Now, as we approach normal policymaking, our communication needs to transition because there is less certainty about the future path of policy,” Mester said. “The economy is dynamic, and the future path of policy will depend on how economic and financial conditions actually change over time. Those changes cannot be fully known in advance, so policy cannot be pre-set.”
And she explained “data-dependent” doesn’t mean the Fed “will react to every short-run change in the data. Some shocks that hit the economy will result in an accumulation of information that changes the medium-run outlook for the economy and the risks around the outlook in such a way that monetary policy will want to respond. But some shocks will not materially change the outlook or policymakers’ views of appropriate policy.”
As she sees it, “The communication challenge, then, is to give the public a good sense of how policy is likely to respond conditional on how the economy evolves without implying that policy is pre-committed to a particular path regardless of how the economy evolves. Our policy statement can help to do this if it does three things: (1) discusses a consistent set of factors that inform our outlook, risks, and progress toward our monetary policy goals; (2) describes how accumulated changes in those economic and financial conditions have or have not affected our outlook and risk assessment since our last meeting; and (3) points to this relationship between accumulated information and our outlook and risk assessment as the rationale for our policy decision.”
