The Federal Reserve Should Consider Less Forward Guidance on Monetary Policy, Says San Francisco Fed President
In a recent address to the Western Economic Association International annual conference, San Francisco Federal Reserve Bank President Mary Daly emphasized the need for the US central bank to reconsider the amount of forward guidance it provides regarding monetary policy decisions, especially during times of uncertainty.
Daly highlighted the power of words in shaping expectations and the challenges of reversing course once expectations have been set. She pointed out that while words can be a useful tool, they can be more difficult to retract than changes in interest rates. As such, she suggested that the Fed should exercise caution in its communication strategies to avoid creating rigid expectations that may not align with the evolving economic landscape.
The Federal Reserve’s approach to forward guidance came under scrutiny in 2021 when it committed to expanding its balance sheet and refrained from raising interest rates until inflation showed sustained progress towards its 2% target. This commitment, intended to address persistently low inflation, was criticized for potentially delaying necessary rate hikes to combat rising inflation.
Drawing from this experience, Daly underscored the importance of flexibility and adaptability in the Fed’s communication practices. She urged the central bank to adopt a more dynamic approach to public communication, especially in times of uncertainty when definitive guidance may prove to be counterproductive.
While the Fed is currently reassessing its policy framework, Daly clarified that her remarks were not directly related to this ongoing review. However, she hinted at potential changes in the Fed’s communication methods, including a reevaluation of the “dot plot” tool, which outlines policymakers’ projected interest rate paths and serves as a reference point for market expectations.
In conclusion, Daly’s call for less rigid forward guidance underscores the need for the Federal Reserve to strike a balance between transparency and adaptability in its communication strategies. By embracing a more flexible approach to guidance, the Fed can enhance its ability to respond effectively to changing economic conditions and foster a more nuanced understanding of its policy intentions among market participants.
