WASHINGTON Federal Reserve officials are warming to the idea of publishing their assumptions about the path of interest rates, a decision that could help ease financial conditions.
For months the Fed had pledged to keep the overnight federal funds rate near zero for an extended period. It hardened that vow in September, saying it would stay ultra-low through at least the middle of 2013.
By offering an assurance that they would be in no hurry to tighten monetary policy at the first signs of the recovery taking off, the central bank was hoping to keep investors from bidding market interest rates up.
But officials are uncomfortable with a pledge that is tied to the calendar and not economic conditions. Adding interest rate projections to their usual quarterly economic forecasts would be a straightforward way of addressing those concerns.
While some Fed officials appear to lean toward the somewhat more conventional step of purchasing bonds if a decision is taken to ease monetary policy further, communications is also on the table.
"The scope remains to provide additional accommodation through enhanced guidance on the path of the federal funds rate or through additional purchases of long-term financial assets," Fed Vice Chair Janet Yellen said on Tuesday.
Economists at 16 of 19 financial firms that trade directly with the Fed said earlier this month they believe the central bank will take more measures to strengthen the U.S. recovery, with 12 expecting a change in communications.
"Given the high degree of liquidity in the government market and the current low levels of long rates, it is not clear how effective additional (bond) purchases would be in pushing rates down further," New York University professor Mark Gertler said.
"Hence the focus on communication as a means to improve the effectiveness on managing the private sector beliefs about the future course of policy," he added.
LOOKING AT THE NUMBERS
A decision on whether to begin issuing forecasts on the path of the overnight federal funds rate could be taken as soon as the Fed's next meeting on December 13.
That would allow officials to bring projections to the table in time for the central bank's regulatory scheduled quarterly economic forecasts in late January.
At the Fed's last meeting early this month, Fed Chairman Ben Bernanke directed a communications committee that Yellen heads to explore the idea of rate forecasting.
On Tuesday, Atlanta Federal Reserve Bank President Dennis Lockhart said that providing the monetary policy assumptions underlying officials' forecasts for GDP, unemployment and inflation would be a useful communications step.
While Yellen equated a potential shift in the Fed's communications strategy with an easing of monetary policy, some more hawkish Fed officials might simply see it as a way to improve policy transparency.
"I imagine what the Fed is working on now is to clarify the circumstances under which it might begin to raise rates," Gertler said.
The approach has been tested: both the Swedish and Norwegian central banks provide this information. One concern has been that markets can view the forecasts as promises.
San Francisco Federal Reserve Bank President John Williams, who rotates into a voting spot on the Fed's policy-setting panel next year, noted that exact pitfall in a paper he co-wrote in 2006. But, he concluded, such problems could be averted as long as the central bank makes it clear that the forecasts are just that.
"Central bank communication of interest rate projections can better align the public's and the central bank's expectations and this better alignment of expectations generally leads to improvements in macroeconomic performance," he wrote.
The Fed long ago exhausted its principal policy tool -- the federal funds rate -- and it has already stretched the unorthodox approach to easing of expanding its balance sheet through bond purchases.
More bond buying is controversial both within the Fed and without, and the economic environment is highly uncertain.
With data signaling a modest pick up in economic growth, even against the backdrop of a troubling debt crisis in Europe, U.S. officials may prefer tweaking their communications framework to buying more bonds.
LAST MAN STANDING
The subcommittee Yellen is leading includes two policymakers who stand at the outer extremes of monetary policy theology -- arch-hawk Charles Plosser from the Philadelphia Federal Reserve Bank and uber-dove Charles Evans of Chicago.
Evans had floated a proposal of setting specific economic triggers that would spark a Fed policy tightening, suggesting perhaps waiting until the jobless rate fells to around 7 percent unless inflation threatened to top 3 percent.
But many Fed officials are wary of enshrining a particular unemployment rate as a tightening trigger, arguing there are too many variables beyond the central bank's control that determine what level of unemployment is consistent with noninflationary growth.
Another long-standing communications approach beloved of many central bankers around the world, including both Plosser and Bernanke, an explicit inflation target, also looks unlikely.
That leaves interest rate forecasting as the most likely option.
Strictly speaking, that additional information would be no more than a clarification of officials' private views and would not be an easing of policy per se. However, to the extent that it might indicate an expectation that any tightening is further off than markets perceive, it could help ease financial conditions as investors adjust their best.
Clarifying rate path assumptions could also help the Fed finesse a looming quandary: whether it needs to extend or change its static mid-2013 low rate pledge as that date draws nearer.