Forward guidance – HubbardOBrienEconomics.com Blog

Fed Chair Warsh Takes a More Hawkish Stand in Address at Jackson Hole

Federal Reserve Chair Kevin Warsh (Photo from federalreserve.com)

Each year since 1982, the Federal Reserve Bank of Kansas City has sponsored an economic policy symposium in Jackson Hole, Wyoming. (The site was supposedly first chosen in the hopes that Fed Chair Paul Volcker would attend because of the opportunities for fly fishing in the local area.)

In most years since 1989, the Fed chair has given the keynote address at the symposium. The address gives the Fed chair a chance to provide his or her assessment of the state of the U.S. economy and the outlook for inflation and employment—the two parts of the dual mandate Congress has given to the Fed.

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This year’s address by Fed Chair Kevin Warsh was highly anticipated. In his press conference following the last meeting of the Fed’s policymaking Federal Open Market Committee (FOMC), Warsh reiterated his determination to bring inflation back to the Fed’s 2 percent annual target. But he faced a number of questions from reporters as to why, with inflation running well above 2 percent, he wasn’t advocating an increase in the FOMC’s target for the federal funds rate. Warsh has stated that he wantesto steer the committee from using forward guidance to affect interest rates. Accordingly he was reluctant to state explicitly what direction Fed policy might take.

Investors in the bond market appear to have interpreted Warsh’s statements as “dovish”; that is, they believed that his reluctance to support rate increases indicated that inflation might remain above the Fed’s target for longer. As we discussed in earlier blog posts, when investors believe that inflation will be higher they require that bond yields rise enough to compensate them for the additional purchasing power. (As we discuss in Money, Banking, and the Financial System, Chapter 4, economists refer to the increase in nominal interest rates following an increase in the expected inflation rate as the Fisher effect.) The rise in the yield on the 30-year Treasury bond in the days following Warsh’s press conference likely reflected bond investors expecting somewhat higher inflation than they had previously.

In today’s address, Warsh attempted to counter the conclusion that he is reluctant to increase interest rates to slow the rate of inflation. First, though, he repeated his opposition to Fed chairs routinely engaging in forward guidance: “Oversharing policy deliberations and overcommitting to future decisions can lead markets, businesses, and households astray. And I believe when policymakers make quasi-commitments on interest rates through the cycle, we inhibit our own freedom to make the right calls when it’s time to decide.”

He again stated forcefully his commitment to the Fed’s inflation target: “The Fed’s price-stability objective of 2 percent, as measured by the personal consumption expenditures (PCE) price index, is a firm, fixed target. … It is the Fed’s job to deliver stable prices.” He noted that all measures of inflation “tell a similar story: Inflation is running above our 2 percent target. So the Fed’s predominant focus right now should be on prices.”

Warsh also observed that “progress over the past two years [toward the 2 percent target] has been modest.” He concluded that: “There is one signal nobody can miss: The responsibility for 65 months of sustained, elevated inflation sits squarely with the central bank. And that is where it belongs.”

The following figure from the Wall Street Journal reflects the bond market’s immediate reaction when the text of Warsh’s address was released.

The two-year Treasury note is directly affected by investors’ expectations of the future path of the federal funds rate. (We discuss this link in Money, Banking, and the Financial System, Chapter 5.) Investors interpreted Warsh’s address as indicating he would take a more “hawkish” view of the need to raise the FOMC’s target for the federal funds rate than he had appeared to take in his earlier press conference.

Investors in the federal funds future market also quickly revised their expectations of the likelihood of the FOMC raising its target for the federal funds rate. Trading in the futures marker resulted in the probability increasing from 35.4 percent yesterday to 57.5 percent this afternoon of the committee raising its target range for the federal funds by 0.25 percentage points (25 basis points) at its next meeting on September 15–16. The probability that after the meeting on October 27–28, the committee will have raised its target range by at least 25 basis points increased from 52.6 percent yesterday to 70.7 percent this afternoon.

FOMC Holds Target Rate Constant, with Three Dissenting Votes

Fed Chair Kevin Warsh and colleagues discuss policy at the June FOMC meeting (Photo from federalreserve.gov.)

There was some uncertainty as to whether at its meeting that ended today, the Federal Open Market Committee (FOMC) would leave unchanged its target range for the federal funds rate at 3.50 percent to 3.75 percent. As of yesterday, trading in the federal funds rate futures market had given a 31 percent probability to the committee raising its target by 0.25 percentage points (25 basis points). The committee voted 9–3 to keep the target range unchanged, with Beth Hammack, president of the Federal Reserve Bank of Cleveland, Neel Kashkari, president of the Federal Reserve Bank of Minneapolis, and Lorie Logan, president of the Federal Reserve Bank of Dallas, voting to raise the target range by 25 basis points.

The FOMC has left its target for federal funds rate unchanged since lowering it by 25 basis points on December 10 of last year. The following figure shows for the period since January 2015, the upper bound (the blue line) and the lower bound (the green line) for the FOMC’s target range for the federal funds rate, as well as the actual values for the federal funds rate (the red line). Note that the Fed has been successful in keeping the value of the federal funds rate in its target range. (We discuss the monetary policy tools the FOMC uses to maintain the federal funds rate within its target range in Macroeconomics, Chapter 15, Section 15.2 (Economics, Chapter 25, Section 25.2).)

As with the policy statement issued following Fed Chair Kevin Warsh’s first FOMC meeting in June, today’s policy statement was short and did not include any discussion of the circumstances under which policy might change in the future—so-called forward guidance. We discuss forward guidance in Macroeconomics, Chapter 15 (Economics, Chapter 25).

In his press conference following the meeting, Warsh expanded on his approach to monetary policy, highlighting differences with previous Fed chairs. He noted that he believed that FOMC policy statements should present “just the facts,” providing only a brief summary of current economic conditions and avoiding mention of future monetary policy apart from the assertion—which also closed the policy statement following the June meeting—that “The Committee will deliver price stability.”

He stressed that the committee was in the process of reassessing its approach to monetary policy. The reassessment will rely in part on the findings of the five committees he has formed, although he noted that the FOMC would not feel bound by the recommendations of the five committees. He emphasized that the committee would focus more on trends in economic data and wouldn’t be “holding our breath” waiting for any particular data release. In reply to questions from reporters, he noted that despite the committee leaving its target for the federal funds rate unchanged, there hadn’t been a “pause” in policy because the committee had continued its “rigorous review of big, hard questions.”

Warsh noted that by avoiding forward guidance, the committee wasn’t attempting to surprise financial markets when at some point it announces a policy change. Instead, he argued that prices in financial markets would now better reflect the opinions of market participants, which will provide the committee with useful information.

On two issues, Warsh noted continuity with committee procedures under previous Fed chairs. First, at his June press conference, Warsh had indicated that he would only hold press conferences after FOMC meetings if there was new information to convey. Today, he stated that, through at least the end of the year, he would continue the recent tradition of holding a press conference after each FOMC meeting. Second, when asked about his statements that new measures of inflation were needed, Warsh indicated that, at least through the end of the year, the committee would continue to measure progress toward its 2 percent annual inflation goal using the inflation rate as measured by the personal consumption expenditures (PCE) price index.

Finally, this afternoon, investors in the federal funds rate futures market assigned a 63.4 percent probability to the committee increasing its target range by 25 basis points at its next meeting on September 15–16, a decrease from 76.0 percent yesterday.

FOMC Holds Target Rate Constant as Warsh Promises Procedural Changes after First Meeting as Chair

Photo of Kevin Warsh from bloomberg.com via the Wall Street Journal

It was a foregone conclusion that at its meeting that ended today, the Federal Open Market Committee (FOMC) would leave unchanged its target range for the federal funds rate at 3.50 percent to 3.75 percent. There was great interest, however, about whether at his first meeting as chair of the committee, Kevin Warsh might indicate changes he would push for in the committee’s procedures.

One immediate change was evident in the statement that the committee released at the end of its meeting. The first statement reproduced below is from April 29, the last meeting Jerome Powell presided over as chair. The second statement is the statement that the committee released today.

The statement released today is much shorter and omits any mention of how the committee might respond in the future to new economic data, other than the simple statement that, “The Committee will deliver price stability.”

The brevity of the statement reflects the skepticism Warsh had voiced in his Senate confirmation hearings on the usefulness of forward guidance, or statements by the FOMC about how it will conduct monetary policy in the future. We discuss forward guidance in Macroeconomics, Chapter 15 (Economics, Chapter 25).

In his press conference following the meeting, Warsh announced that he was forming five new committees to look at: 1) Fed communications, 2) the Fed’s balance sheet, 3) the Fed’s use of data, 4) the effects of technological change and productivity, particularly with respect to artificial intelligence, and 5) the inflation process, with the aim of identifying key drivers of inflation. He indicated that the committees would include members from outside the Fed and were expected to report their findings by the end of the year.

After the meeting, the committee also released a “Summary of Economic Projections” (SEP)—as it typically does after its March, June, September, and December meetings. The SEP presents median values of the, typically, 19 committee members’ forecasts of key economic variables. Notably, Warsh indicated that, although he encouraged his colleagues on the committee to continue submitting their forecasts to be compiled in the SEP, he didn’t submit forecasts. He indicated that the future of the SEP is one of the issues to be considered by his new committee on Fed communications.

The forecasts of key economic variables from the SEP are summarized in the following table, reproduced from the release. (Note that only 5 of the district bank presidents vote at FOMC meetings, although all 12 presidents participate in the discussions and prepare forecasts for the SEP.)

There are several aspects of these forecasts worth noting:

Compared with the previous SEP in March, the committee members reduced their forecast of real GDP growth in 2026 from 2.4 percent to 2.2 percent. The committee members left unchanged their forecast of long-run growth in real GDP at 2.0 percent. Despite reducing their forecast of real GDP growth in 2026, the committee lowered their forecast of the unemployment rate in 2026 from 4.4 percent to 4.3 percent. The committee members left their forecast of the long-run rate of unemployment, often called the natural rate of unemployment, unchanged at 4.2 percent.
Committee members significantly raised their forecast of personal consumption expenditures (PCE) price inflation in 2026 to 3.6 percent from 2.7 percent in March. They raised their forecast of inflation in 2027 slightly and continued to forecast that PCE inflation will decline to the Fed’s 2.0 percent annual target in 2028.
The committee’s forecasts of the federal funds rate at the end of each year from 2026 through 2028 were increased, indicating that the committee sees the federal funds rate as likely to be “higher for longer.” The forecast for the long-run federal funds rate was left unchanged at 3.1 percent.

Prior to the meeting, there was much discussion in the business press and among investment analysts about the dot plot, shown below. Each dot in the plot represents the projection of an individual committee member. (The committee doesn’t disclose which member is associated with which dot.) Note that there are 18 dots, representing the 6 members of the Fed’s Board of Governors who provided forecasts and all 12 presidents of the Fed’s district banks.

The dots plotted on the far left of the figure represent the projections by the 18 members of the value of the federal funds rate at the end of 2026. The plots indicate that at this point eight members of the committee forecast no change in the federal funds rate this year, nine members (circled in red) expect at least one increase in the federal funds rate by the end of the year, and only one member expected that there would be a cut in the federal funds by year’s end. The dots plotted on the far right of the figure indicate that there is substantial disagreement among committee members as to what the long-run value of the federal funds rate—the so-called neutral rate—should be. Of course, the plots only represent the forecasts of the committee members and individual committee members are likely to adjust their forecasts as additional macroeconomic data become available in the coming months.

Warsh indicated at his press conference that it was unlikely that he would hold a press conference after each meeting of the committee as Jerome Powell had been doing beginning with the January 2019 meeting.

Warsh made several other notable points at the press conference. He reiterated that the Fed’s inflation target would remain an annual increase of 2.0 percent in the PCE. He noted that he saw the current level of the federal funds rate as having a restrictive effect on only the housing market. And he expressed dissatisfaction with how the economic statistics the FOMC relies upon when setting policy were being compiled. He indicated that the new committee on the Fed’s use of data might formulate suggestions to other federal government agencies, such as the Bureau of Economic Analysis and the Bureau of Labor Statistics, on changes in how they collect data.

The Fed Continues to Walk a Tightrope

Photo from the Associated Press of Fed Chair Jerome Powell at a news conference

At its Wednesday, May 3, 2023 meeting, the Federal Open Market Committee (FOMC) raised its target for the federal funds rate by 0.25 percentage point to a range of 5.00 to 5.25. The decision by the committee’s 11 voting members was unanimous. After each meeting, the FOMC releases a statement (the statement for this meeting can be found here) explaining its reasons for its actions at the meeting.

The statement for this meeting had a key change from the statement the committee issued after its last meeting on March 22. The previous statement (found here) included this sentence:

“The Committee anticipates that some additional policy firming may be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time.”

In the statement for this meeting, the committee rewrote that sentence to read:

“In determining the extent to which additional policy firming may be appropriate to return inflation to 2 percent over time, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.”

This change indicates that the FOMC has stopped—or at least suspended—use of forward guidance. As we explain in Money, Banking, and the Financial System, Chapter 15, Section 5.2, forward guidance refers to statements by the FOMC about how it will conduct monetary policy in the future.

After the March meeting, the committee was providing investors, firms, and households with the forward guidance that it intended to continue raising its target for the federal funds rate—which is what the reference to “additional policy firming” means. The statement after the May meeting indicated that the committee was no longer giving guidance about future changes in its target for the federal funds rate other than to state that it would depend on the future state of the economy. In other words, the committee was indicating that it might not raise its target for the federal funds rate after its next meeting on June 14. The committee didn’t indicate directly that it was pausing further increases in the federal funds rate but indicated that pausing further increases was a possible outcome.

Following the end of the meeting, Fed Chair Jerome Powell conducted a press conference. Although not yet available when this post was written, a transcript will be posted to the Fed’s website here. Powell made the following points in response to questions:

He was not willing to move beyond the formal statement to indicate that the committee would pause further rate increases.
He believed that the bank runs that had led to the closure and sale of Silicon Valley Bank, Signature Bank, and First Republic Bank were likely to be over. He didn’t believe that other regional banks were likely to experience runs. He indicated that the Fed needed to adjust its regulatory and supervisory actions to help ensure that similar runs didn’t happen in the future.
He repeated that he believed that the Fed could achieve its target inflation rate of 2 percent without the U.S. economy experiencing a recession. In other words, he believed that a soft landing was still possible. He acknowledged that some other members of the committee and the committee’s staff economist disagreed with him and expected a mild recession to occur later this year.
He stated that as banks have attempted to become more liquid following the failure of the three regional banks, they have reduced the volume of loans they are making. This credit contraction has an effect on the economy similar to that of an increase in the federal funds rate in that increases in the target for the federal funds rate are also intended to reduce demand for goods, such as housing and business fixed investment, that depend on borrowing. He noted that both those sectors had been contracting in recent months, slowing the economy and potentially reducing the inflation rate.
He indicated that although inflation had declined somewhat during the past year, it was still well above the Fed’s target. He mentioned that wage increases were still higher than is consistent with an inflation rate of 2 percent. In response to a question, he indicated that if the inflation rate were to fall from current rates above 4 percent to 3 percent, the FOMC would not be satisfied to accept that rate. In other words, the FOMC still had a firm target rate of 2 percent.

In summary, the FOMC finds itself in the same situation it has been in since it began raising its target for the federal funds rate in March 2022: Trying to bring high inflation rates back down to its 2 percent target without causing the U.S. economy to experience a significant recession.