the Fed’s communication. Ahead of it, he has sketched out his views
on his Brookings Institution blog here.
Most of the discussion is on the
Summary of Economic Projections (SEP), the infamous dot plot. Bernanke
defends this communication tool, but implicit in the defense is a recognition
that the tool is often misunderstood and misused.
Bernanke begins off with what the dot plots aren’t. They are
not, he explains, a policy commitment by the FOMC. The idea that end of
the of last year, the dots showed four hikes this year was not an implicit or
explicit promise. That the four hikes have not materialized does not mean
that Fed misleads or lied, as some would
have it. The dots are not a consensus view at the Fed. They are compiled by the individual participants.
Bernanke could not be clearer. “If the FOMC as a whole is
going to make a commitment or provide explicit guidance about the future rate
policy, it will do that in its post-meeting statement, or the chair will
communicate it.”
The SEP is not a composite of unconditional economic forecasts, the
former Fed chairman notes. The dots do not reflect what the official
think is likely to happen. The projections are based on views of “appropriate monetary
policy.” He provides an illustration of what this may mean in
practice. An official who thinks the policy
is too dovish may anticipate that rates
may remain low, given the FOMC consensus, but may lift the inflation
forecast. However, the official may submit dot plots that reflect what
the official thinks are proper policy,
maybe higher rates as inflation moves toward the target.
In addition, Bernanke notes that
projections are simply the most likely scenario not a range of possible
scenarios. Also, the
statistical uncertainty of any economic forecast is high, and the SEP are not
exceptions to this rule. The dot plots do
not reflect that uncertainty or other
possible scenarios.
Given these parameters, Bernanke defends the dot plot tool. The
former Fed Chairman sees the dots a straw poll. It provides the chair
with a sense of the range of opinions before the full FOMC meeting. It
also provides insight into how the thinking of the different participants is
evolving. Bernanke appears to give greater policy signaling strength to
the nearer term projections as opposed to the projections over the longer horizon.
He notes that all but three officials in September anticipated that a hike
before the end of the year would be appropriate, and it does seem that the Fed
will move next month.
Bernanke also argues that the dots provide important information for
long-run economic parameters. These include what economists call the
natural rate of unemployment (consistent with stable prices), the trend growth
rate (sustainable pace) and the equilibrium rate of the Fed funds.
The Fed does not provide long-term estimates for these variables, so the SEP is
the best that investors may find.
The reaction function refers to how Fed officials respond to economic
developments. Bernanke suggests that another value of SEP is that it
sheds light why the anticipated interest rate views change over time. He
has argued in the past, for example, that the Fed’s projected rate path is has
been shifted lower in recent years can be traced to officials’ changing views
on key parameters, like the equilibrium rate of short-term interest rates and
the natural rate of unemployment. Bernanke concedes to the SEP critics
that individual participant views cannot simply be aggregated to reach a Fed
decision.
However, Bernanke reveals that on his tenure, there was some experimentation
but nothing appeared to work to generate aggregate forecasts in a timely
fashion. He supports the continued exploration of ways to improve SEP, but defends it on the grounds that it does provide useful
information to investors provided they understand what it is and
isn’t. The SEP will be updated next month.