The Fed’s Forward Guidance and Forecasting Inconsistencies

By Mickey Levy

The Fed’s effort to manage market expectations and aggregate demand through forward guidance may generate as many inconsistencies and misinterpretations as benefits, particularly as the Fed constantly changes its guidance. The Fed’s economic forecasts and assessment of the future appropriate path of the Federal funds rate add to the mixed messages and confusion.

The Fed’s forward guidance on when it may taper its asset purchases and the timing of rate hikes attempts to suppress interest rates until economic growth strengthens. But the longer the economy recovers from financial crisis and recession and the more the unemployment rate falls, potential inconsistencies arise between the Fed’s monetary policy and its long-run objectives. The appropriateness and sustainability of the Fed’s projection of a sustained negative real Fed funds rate through year-end 2016 and an ever-expanding Fed balance sheet are increasingly questionable as economic growth pushes the unemployment rate to its natural rate.