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The Fed s interest-rate projections

2015-06-16 06:03:21

Dotty

A chart intended to provide insight actually sows confusion

Jun 13th 2015

INVESTORS obsess over the Federal Reserve s dot-plots . These charts show the

rough trajectory that senior Fed officials think its benchmark interest rate

should follow over the next few years. Before every second meeting of the

rate-setting Federal Open Market Committee (FOMC), members say how high they

think the rate should be at the end of the current year and the two subsequent

ones. Each estimate is then plotted as an anonymous dot on a chart, to provide

a sense of the range of views within the FOMC. For instance, at its meeting in

March, seven of the 17 members thought that the benchmark rate should be 0.625%

by the end of the year (see chart). They will now be preparing new dots for

their next meeting, on June 16th-17th.

At first glance, the dot-plots seem to offer a wealth of information. For

instance, they show that there is plenty of disagreement within the FOMC. Its

two most dovish members think the rate should remain where it is (a range of

0-0.25%) until the end of the year, whereas its fiercest hawk wants the rate to

rise to 1.625%. For the end of 2016, the range is even wider: 0.375% to 3.75%.

But the dot-plots are less useful than they appear. For one thing, the FOMC

consistently overestimates future rates. Its projections have moved steadily

downward since the chart s inception, due to disappointing economic data. The

very first dot-plot, in January 2012, suggested that the rate would have topped

1% by the end of last year.

Moreover, no one not even the members of the FOMC knows for sure whose dot is

whose. This is a problem because each member s view is not of equal value. Only

12 of them have a vote on monetary policy. One of the dots that of Janet

Yellen, the Fed s chair is more important than all the others. Worse, there is

no explanation of how members reached their decisions, or how confident they

feel about them. For instance, hawks may look as if they are moderating their

views when they are not. They may think the FOMC should already have started

raising the rate, but since it hasn t yet done so, they have no choice but to

reduce the level they think the rate could plausibly reach by the end of the

year.

All this means that the dot-plots are of limited use for understanding monetary

policy. At times, Ms Yellen seems to agree. When trying to prime the market for

future rate rises, she argued that people should not look to the dot-plot to

understand the FOMC s intentions. Yet at a recent press conference she pointed

to downward revisions of the dot-plot to bat away suggestions that the

committee was in a tightening mood. If Ms Yellen cannot decide how significant

the chart is, what hope is there for the rest of us?