MNI INTERVIEW: Limits To Comms Benefits From Fed Scenarios
Former Fed Board research director David Wilcox outlines challenges around implementing scenario-based forecasting and communications at the Fed.
The Federal Reserve could usefully provide more discussion of risks to its outlook, but the scenario-based analysis put in the spotlight by former Chair Ben Bernanke could only be adopted on an informal basis within the Fed system, with limited benefits for its communications, former Fed Board of Governors research director David Wilcox told MNI.
Many of the pieces needed to create scenario-based forecasts are missing at the Fed, Wilcox said in an interview following Bernanke’s recommendation last month that the Bank of England expand its use of scenarios to quantify risks to its central forecast.
The FOMC has no agreed-upon monetary policy rule for calculating the policy response to various scenarios, or a collectively-certified forecast, as the BoE has, but rather only the tally of individual views in its quarterly Summary of Economic Projections, said Wilcox, now an economist with the Peterson Institute for International Economics and Bloomberg Economics.
DIFFERENT INFRASTRUCTURE
Nor does the Fed have a system-wide macroeconomic model like the BoE's COMPASS that would help sketch out a baseline outlook for the economy or the implications of alternative economic conditions, he said. The Fed Board and some reserve banks use the FRBUS model but the FOMC has never been willing to endorse it as a baseline.
"Those bits of infrastructure are not in place for the FOMC, so that makes a full implementation of his vision exceedingly difficult,” Wilcox said.
In Bernanke’s review, prompted by the BOE’s failure to anticipate the surge of inflation during the Covid-19 pandemic, the former Fed chair argued that a scenario-based approach would help educate the public about the central bank's reaction function in response to unexpected developments.
But, "It’s a pretty complicated way to go about that," Wilcox said. "A more simple way is to endorse a reaction function, not as providing a mechanical answer on how they will behave, not tying their hands or representing an ironclad commitment, but a rough guide."
LESS FORMAL APPROACH
A stronger rationale for using scenario-based analysis would be to offer a way for policymakers to underscore the extent of the uncertainty, and a less formal approach could yield many of the benefits Bernanke outlined in his report, Wilcox said.
Some FOMC members have already taken to discussing scenarios -- of inflation staying sticky rather than continuing to cool, for example -- in their speeches in recent weeks.
"It’s always uncertain, but it’s difficult for people on the outside to appreciate that," Wilcox said. "It is helpful to talk more about specific possibilities for how things might work out differently than seen in the baseline to make the uncertainty more tangible, more relatable to the audience."
But the FOMC must consider the public has limited bandwidth to absorb even more nuanced information about the economic outlook from the central bank, he said. (See MNI: Fed Messaging Swings Boost Policy Volatility -Ex-Officials)
A ranking of what the FOMC views as the most salient risks to its outlook at any given moment could be useful, but even that would put the central bank in the awkward position of appearing to meddle in politics, if fiscal policy were to top the list.
"If the FOMC ever were to go whole hog and implement scenario-based analysis," Wilcox said, "I don’t think you'd get a full spectrum view of the risks. You’d get a censored view."