Informing the public about the Federal Reserve
How does forward guidance about the Federal Reserve's target for the federal funds rate support the economic recovery?
Clear communication is always important in central banking, and is especially important in the present circumstances when the economy requires further policy stimulus but the traditional tool of monetary policy, the target for the federal funds rate, is already effectively as low as it can go. (Since December 2008, the Federal Reserve's target for the federal funds rate has been between 0 and 1/4 percent.) Through "forward guidance," the Federal Open Market Committee provides an indication to households, businesses, and investors about the stance of monetary policy expected to prevail in the future. By providing information about how long the Committee expects to keep the target for the federal funds rate exceptionally low, the forward guidance language can put downward pressure on longer-term interest rates and thereby lower the cost of credit for households and businesses, and also help improve broader financial conditions.
Following their December 2012 meeting, Federal Reserve policymakers indicated that they anticipated that a target range for the federal funds rate of 0 to 1/4 percent will be appropriate at least as long as
- the unemployment rate remains above 6-1/2 percent,
- inflation between one and two years ahead is projected to be no more than 1/2 percentage point above the Committee's 2 percent longer-run goal, and
- longer-term inflation expectations continue to be well anchored.
At its December 2013 meeting, the Committee indicated that, in determining how long to maintain a highly accommodative stance of monetary policy, it will consider other information including additional measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. The Committee now anticipates, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6-1/2 percent, especially if projected inflation continues to run below the Committee's 2 percent longer-run goal.
The formulation of the forward guidance based on thresholds helps to clarify policymakers' intention to maintain accommodation for as long as needed to promote a stronger economic recovery in a context of price stability. And, by more clearly describing the connection between future monetary policy and economic conditions, forward guidance helps to make monetary policy more transparent and predictable to the public, thereby contributing to more rapid and automatic adjustments in financial markets to changes in economic conditions.
The 6-1/2 percent threshold for the unemployment rate should not be interpreted as policymakers' longer-term objective for unemployment. Most policymakers estimate the longer-run normal rate of unemployment is between 5.2 and 5.8 percent. However, because changes in monetary policy affect the economy with a lag, policymakers recognize that it will be necessary to begin moving away from highly accommodative policy before the economy reaches maximum employment.
Neither the unemployment rate threshold nor the inflation threshold should be viewed as triggers that would automatically lead to the immediate withdrawal of accommodative policy. Policymakers recognize that no single indicator provides a complete assessment of labor market conditions or the outlook for inflation. In addition, when the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent.