MacroScope

Time for Fed to rethink its forward guidance?

October 8, 2013

Federal Reserve officials have largely acknowledged by now that leading markets to believe the central bank would reduce its bond buying stimulus in September and then failing to do so was a communications blunder.

For Zach Pandl, a former Goldman economist now at Columbia Management, this means the Fed may have to reshape its guidance to financial markets – even if the exact contours of the changes remain unclear.

Last month’s surprise may have increased the odds that the committee will rework its forward guidance in some way (though this will depend importantly on the identity of the next Fed Chair).

Chairman Bernanke appeared to back away from the threshold-based guidance given at the December 2012 and June 2013 meetings, but he was noncommittal about what changes the committee could make in the future. Plus, if Fed officials were to revise their views on the costs and/or efficacy of QE, they may attempt to lean harder on the forward guidance tool.

Charles Plosser, president of the Philadelphia Fed said on Tuesday the central bank undermined markets’ trust in its promises by not living up to expectations of a reduction in the pace of bond purchases in September.

To delay tapering of our current asset purchase scheme without clear and significant departures from prior guidelines suggested the FOMC was changing the goalposts and deviating from June’s forward guidance. This undermines the credibility of the Committee and reduces the effectiveness of forward guidance as a policy tool. It also contributes to additional uncertainty regarding the future course of monetary policy.

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