Fed-bots: Goldman models central bankers

January 9, 2012

Forecasting hard data can be difficult enough. Estimating the forecasts of individual Federal Reserve policymakers is even tougher. But, in advance of the Fed’s latest effort at policy transparency, that’s just what Goldman Sachs economists have attempted to do.

The Fed announced last week it would begin publishing policymakers’ own forecasts for the path of interest rates, in addition to the growth, inflation and employment projections they already release on a quarterly basis. Goldman uses the Taylor rule of monetary policy, which governs the relationship between economic slack and inflation, to estimate when individual policymakers would likely perceive the timing of an eventual interest rate hike.

The findings are interesting, particularly because they find that, contrary to the view chronicled in this post, the publication of Fed officials’ forecasts might actually have the effect of tightening financial market conditions.

Given a broad range of economic forecasts, the range of participants’ funds rate projections is likely to be wide. Our estimates – which rely on participants’ economic forecasts and our Taylor rule – suggest that the central tendency (the range of forecasts by all 17 participants minus the highest and lowest three) might span from zero to 2.75 percent at end-2014, with a mid-point of 1.5 percent. These estimates point to the danger that financial conditions could tighten with the publication of such forecast ranges, as the market is currently pricing only around 75 basis points of rate hikes by the end of 2014.

To counter this potential consequence, the Fed could choose to offer clarity on participants’ expectations for additional bond purchases. By highlighting the fact that some officials still see the need for further monetary stimulus, the central bank would shift the perceived mid-point of market expectations for official rates.

It will be difficult for the FOMC to ease financial conditions significantly by publishing participants’ funds rate projections. But if sufficient detail is provided—including the distribution of funds rate projections and an indication that several participants are in favor of additional asset purchases—a modest boost to financial conditions appears likely.

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