The Influence and Policy Signalling Role of FOMC Forecasts

Published date01 October 2015
Date01 October 2015
©2015 The Department of Economics, University of Oxford and JohnWiley & Sons Ltd.
doi: 10.1111/obes.12093
The Influence and Policy Signalling Role of FOMC
Paul Hubert
OFCE – Sciences Po. 69 Quai d’Orsay, 75340 Paris, Cedex 7, France
Federal Open Market Committee (FOMC) policymakers have published macroeconomic
forecasts since 1979 and we examine the effects of FOMC inflation forecasts using a
structural VAR model. First,we assess whether they influence private inflation expectations.
Second, we investigate the underlying mechanism at work and whether they convey policy
signals. We provide original evidence that FOMC inflation forecasts influence privateones.
We also find that the influencing effect of FOMC forecasts does not come through current
Fed rate changes, that FOMC forecasts affect private expectations in a different way than
current policy decisions, and that FOMC forecasts are informative about future Fed rate
I. Introduction
Most theoretical models emphasize the importance of private expectations in determining
macroeconomic outcomes. Hence, managing inflation expectations is a crucial feature of
monetary policymaking and matters all the more when the conventional instrument is at
the zero lower bound (ZLB). In its traditional form, the expectations channel is subtle
and fragile as it depends on private agents’ interpretation of interest rate changes. King
(2005) states that ‘because inflation expectations matter (…), the critical aspect of monetary
policy is how decisions of the central bank affect those expectations’. Policy decisions can
be understood in various ways and facilitating private agents’ information processing is
one reason why central banks complement their actions with communication. Moreover,
given the delay between policy actions and their real effects, communication provides
policymakers with a way to promptly affect private expectations to shorten the policy
transmission lags.
*I thank the Editor, an anonymous referee, Christophe Blot, Camille Cornand, J´erˆome Creel, Michael Ehrmann,
Fabien Labondance, Becky Maule, Harun Mirza, Francesco Saraceno and Xavier Timbeau for useful comments
and suggestions, as well as seminar participants at OFCE, the 2012 European Meeting of the Econometric Society
(Malaga), and the 29th GdREAnnual Inter national Symposium on Money,Banking and Finance (Nantes). This paper
previously circulated under the title ‘Central Bank Forecasts as an Instrument of Monetary Policy’.Any remaining
errors are my own responsibility.
JEL Classification numbers: E52, E58
656 Bulletin
Surprisingly, there have been only a few studies testing whether central bank com-
munication influences private inflation expectations. Most papers in this line of literature
focus on the responses of financial markets, interest rates or exchange rates to central bank
communication (Blinder et al., 2008). It is noteworthy that most of this literature focuses
on qualitative central bank communication (statements, minutes or speeches), even though
communication can take a quantitative form (central bank macroeconomic forecasts). The
latter has the advantage that its use is not based on judgmental classifications (content
analysis, word counting, etc) and it is possible to assess its quality. To our knowledge, only
Fujiwara (2005) and Ehrmann, Eijffinger and Fratzscher (2012) have shown that central
bank forecasts may affect private inflation forecasts; however, both analyses focus on the
dispersion of private forecasts.
The Federal Open Market Committee (FOMC), responsible for the implementation of
US monetary policy, publishes inflation forecasts as part of its Monetary Policy Report to
the Congress. That occurred two times per year between 1979 and 2007 and has occurred
four times per year since 2007. This paper aims at investigating whether and how FOMC
inflation forecasts influence the median of private inflation expectations. This question
matters as policymakers should be able to shape private inflation expectations to make
monetary policy implementation more effective.
Two hypotheses maybe put forward to explain why central bank inflation forecasts may
influence private ones. First,central banks may have different information sets from, and/or
lower forecast errors than, private agents so the latter could use central bank forecasts to
produce more accurate forecasts of the economic outlook. Second, because FOMC fore-
casts are conditional on FOMC members’ views of ‘appropriate’future monetar y policy,
they may convey policy signals, help understand the stance of monetary policy and shed
light on policymakers’ preferences and objectives.1
Romer and Romer (2008) show that FOMC inflation forecasts do not contain useful
additional information compared to FRB staff’s forecasts when predicting future inflation,
while Gavin and Pande (2008) find evidence that FOMC forecasts are not more accurate
than private ones. Ellison and Sargent (2012) argue that FOMC forecasts depict a worst-
case scenario used to design robust policy decisions. Finally, Orphanides and Wieland
(2008) show that FOMC forecasts have more explanatory power for Fed rate decisions
than observed economic outcomes. Results from these papers support the idea that the
source of FOMC forecasts’ influence would be from conveying signals rather than from
their forecast accuracy.
We examine the influence of FOMC inflation forecasts in determining private infla-
tion forecasts using a structural VAR model to identify FOMC inflation forecast shocks
independent of private inflation expectations, the Fed funds interest rate, inflation and real
GDP. The VAR model enables us to assess the dynamics of such a shock in contrast to an
event-study or a regression that would only provide an estimate of the immediate 1-period
effect. We use the Sur vey of Professional Forecasters (SPF) to measure private inflation
forecasts, and add them and FOMC inflation forecasts to a standard monetary VAR with
the Fed rate, inflation and real GDP. FOMC inflation forecast shocks are identified by
1A third explanation is that central bank forecasts may act as public signals whichprovide a focal point for private
agents to coordinate on when prices are strategic complements and agents seek to coordinate (Morris and Shin, 2002),
but this is more likely to affect the dispersion of privateexpectations (Hubert, 2014).
©2015 The Department of Economics, University of Oxford and JohnWiley & Sons Ltd

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