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Why is the Committee’s forward guidance qualitative?

Mayur Sontakke

Dr. Stein on monetary policy communication: Overview (Part 3 of 8)

(Continued from Part 2)

FOMC’s forward guidance

Market participants felt that they didn’t have any clear directional implications for the total amount of accommodation to be provided through asset purchases after Ben Bernanke, then chairman, mentioned the taper in June 2013. However, Dr. Stein argued that the guidance should take a different form as the economy gets closer to the preset quantitative thresholds giving way to more qualitative and less deterministic communication.

In the March 2014 meeting, the Federal Open Market Committee (or FOMC) replaced the earlier quantitative threshold of 6.5% unemployment and 2% inflation with a more generic approach involving a host of labor market indicators. Chairwoman Janet Yellen said, “Monetary policy will be geared to evolving conditions in the economy, and the public does need to understand that as those views evolve, the Committee’s views on policy will likely evolve with them. And that’s a kind of uncertainty that the Committee wouldn’t want to eliminate completely from its guidance because we want the policy we put in place to be appropriate to the economic conditions that will prevail years down the road.”

Dr. Stein advocated Chairwoman Yellen’s views and said that the “forward guidance will be less commitment-like and, hence, a less precise guide to our future actions than it has been in the recent past.”

Chairwoman Yellen also mentioned, at the press conference after the March meeting, that the rate hike may start roughly six months after the end of bond buying program. The statement took the bond market (BND) by surprise because investors were expecting that the rate hike would not start before the end of 2015. The possibility of earlier-than-expected rate hike caused havoc in the bond markets. Also, it led to a drop in the prices of bonds and bond ETFs such as the iShares 20+ year Treasury Bond (TLT), the iShares 7–10 year Treasury Bond (IEF), the iShares 3–7 year Treasury Bond (IEI), and the iShares iBoxx $ Invst Grade Crp Bond (LQD) on March 19.

To learn about how FOMC handles disagreements between its members, continue reading the next part of this series.

Continue to Part 4

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