NEW YORK (Reuters) - A top Federal Reserve official on Friday strongly defended the central bank’s efforts to guide expectations on interest rates, saying that while so-called forward guidance is a blunt tool, it is powerful.
John Williams, president of the San Francisco Fed and one of three policymakers charged with shaping the central bank’s communications strategy, made his comments in response to critique of forward guidance presented by leading Wall Street economists at a forum on U.S. monetary policy in New York.
The economists argued that forward guidance mutes financial market sensitivity to economic data, and thus can foster excessive risk-taking. The Fed and other central banks, they argued, should instead emphasize that their decisions on rates will depend on the economic data, and cannot be predicted in advance with any certainty.
Williams, who more than perhaps any other Fed official has emphasized that Fed decisions are data-dependent, nevertheless took issue with the critique. He presented his own research to show that forward guidance in and of itself does not make bond markets unresponsive to data.
And when interest rates are near zero, explicit and simple guidance on how long they can be expected to remain there is a better central banking tool than intricate, data-conditional messages that are likely to be ignored anyway, he said.
“Although it’s understandable to want to communicate a comprehensive view of monetary policy with all of its incumbent uncertainties, the public has only so much bandwidth dedicated to central bank messaging,” Williams said in remarks prepared for delivery Friday. “So, like a sledgehammer, strongly worded forward guidance can be a powerful tool when it’s needed.”
Williams stopped short of advocating forward guidance in all instances, adding that “like a sledgehammer, care needs to be taken when and where it is used.”
But his comments, coming ahead of a key Fed policy meeting in March, suggest he sees a role for explicit guidance particularly when market expectations diverge sharply from those of the Fed. That was the case in 2011, when the Fed all but promised no rate hikes for at least two years, a move that sharply shifted investor expectations to be more in line with the Fed’s.
Today market expectations again diverge from those at the Fed, with traders betting on no rate hikes this year, and the Fed counting on several.
“Vague hints about future policy seem to be ineffective,” Williams said.
Reporting by Jonathan Spicer, writing by Ann Saphir; Editing by Chizu Nomiyama