Monday, January 23, 2012

Federal funds rate forecasts

Participants on the FOMC will begin publishing their expectations regarding the future path of the federal funds rate this week. This is not dissimilar from the driver of a car informing the car's passengers of his plans for adjusting the steering wheel during the course of the ride. Quite frankly, the passengers couldn't care less. What they want to know is the car's destination. Similarly, the markets couldn't care less what the Fed plans to do with its policy interest rate. What they want to know is the Fed's objective. If the markets know that we're going to see 2% inflation, or 5% NGDP growth, or whatever, then it doesn't help one bit for them to know the forward path of interest rates that the FOMC thinks will get us there.

Repeat after me: the instrument is not the target; the steering wheel is not the destination; the federal funds rate is not the economy's nominal anchor.

1 comment:

  1. [...] it looks as if the FOMC read my post about the importance of setting a nominal target, as they have decided to adopt an inflation target of 2%. This is not my preferred policy, but it [...]