Federal Reserve Forecasts

This morning, the Federal Reserve released forecasts of interest rates for several years out. This has raised considerable debate on the subject of these forecasts. The Fed has moved in this direction to and claimed that it will increase transparency in the Fed's actions and calm markets. This action is supposed to reduce the uncertainty over how the Fed will set interest rates. The Fed has repeatedly said that they plan on keeping interest rates low for an extended period, but traders continually speculate as to what they will actually do. Where uncertainty as to statements made by any central bank relates to how strong commitment device is; a central banker can make any statement they want and then whenever they feel like it can do the opposite. Without an adequate commitment device, traders in the market discount the actions of the central bank, thereby lessening their effectiveness. While these projections are not as effective a commitment device as pledging to "fall on your sword," they do help as diverging from forecasts leads to credibility issues.

As to John Mason's comment:

"to produce projections of interest rates three years into the future? Come on…"

No, you come on; these projections aren't coming from some investment banker who has to use the market rate, but from the people who actually SET THE RATE. While the actual interest rates are set according to market conditions, they are able to make projections into the future and come up relatively close to those figures; they have also pledged to update these figures as things change. Another of Mason's comments is completely erroneous:

"…uncertainty should surround its goals because this allowed markets to move incrementally due to the fact that market participants had to search for where the Fed was moving."

The only reason a central bank would want uncertainty is to "fool" market participants. This policy of "fooling" only works a couple times and then renders the remaining policies ineffective. The idea that markets incrementally because of uncertainty has no basis in reality. Uncertainty in any market leads to jumps in prices as speculators push prices one way or another. A perfect example is in futures markets (which historically have had the highest levels of swings due to speculation) during World War II where food prices were fixed; the Merc and Chicago Board almost folded because they had nothing to trade. Knowledge of where any commodity, stock, or bond yield is going to be will decrease levels of trading and reduce spreads as volatility WILL decrease. These forecasts lead us closer to "perfect information"," less uncertainty in markets, and more confidence in the central bank's actions.

The arguments against these interest rate projections are a red herring; it appears that the main criticism to these policies is the fact that short and medium term rates are significantly too low and appear to remain there. These are not criticisms on increased transparency, but rather where the rates are actually set. In my "expert" opinion, this is a beneficial movement towards more stable markets and decreasing the amount of speculation and volatility in the market.