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MNI (Washington)
WASHINGTON (MNI)

Official quarterly economic projections proved to be an important vehicle for communicating the Federal Reserve's objectives on holding down inflation, helping anchor expectations years ahead of the formal adoption of a 2% target in 2012, according to research from the Kansas City Fed.

Staff economists Brent Bundick and A. Lee Smith found that price expectations became significantly less sensitive to inflation data after the Fed added a longer-run forecast to its Summary of Economic Projections in 2009, three years before it codified the 2% target.

Initial FOMC projections for longer-run inflation ranged from 1.5% to 2% and were centered around 1.8%, suggesting that "inflation expectations may have initially anchored somewhere below the 2% target that was eventually adopted in 2012," Smith said in an interview Friday. Since 2012, the longer run inflation expectation in the SEP has been 2%.

"What surprised us is the importance of the early communication of adding the longer run inflation to the SEP in 2009 and the instrumental role that played in anchoring inflation expectations," he said. "The 2012 announcement wasn't as instrumental as maybe we thought it was."

Reaction Function

The research comes days after the Fed said it was prepared to tolerate periods of above-2% inflation after a decade of undershooting its target and amid sagging inflation expectations. Part of the reason for the changes is to make sure markets see the inflation goal as symmetrical, and because officials learned in the last expansion they could run the job market much hotter than they thought without a big lift to prices.

Fed Vice Chair Richard Clarida is also leading an effort to improve Fed communications, including the SEP, to be concluded around year-end. Some have suggested the Fed release consensus forecasts instead of a collection of individual policymaker projections.

Smith and Bundick declined to extrapolate the results of their research to future Fed communications. "The SEP has been an important tool and probably will remain so," Bundick said. "It lets you communicate your longer run objective and helps people understand your reaction function."

MNI Washington Bureau | +1 202-371-2121 | jean.yung@marketnews.com
MNI Washington Bureau | +1 202-371-2121 | jean.yung@marketnews.com

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