Federal Open Market Committee Policy Research Articles

Economic Prediction with the FOMC Minutes: An Application of Text Mining

We conduct a sentiment analysis of the FOMC (Federal Open Market Committee) minutes based on the text mining results and examine the predictive ability of the resulting sentiment indicators. An adaptive Bayesian approach is employed to build the sentiment indicator for each of the Fed's mandates. We also improve existing mining techniques by identifying economics-related compound words and terminology in the minutes. Our empirical study shows that the mandate-specific indicators exhibit distinct patterns which help illustrate the FOMC's policy emphasis in different periods. It is also shown that these indicators are useful in predicting economic variables and generating superior out- of-sample forecasts. These results support the existing findings that the Fed possesses valuable information about the U.S. economy.

Connecting the dots: Market reactions to forecasts of policy rates and forward guidance provided by the Fed

AbstractThis paper compares market reactions to forecasts of the policy rate path by the Federal Open Market Committee (FOMC) participants with those to forward guidance from the FOMC post‐meeting statements. The forecasts are those by FOMC participants in the quarterly Summary of Economic Projections (SEP; the “dots”). We conduct the analysis during the period when the FOMC's policy rate was at the zero lower bound. We find that market expectations of the time to lift‐off from the zero lower bound are significantly affected in the expected direction by surprises in SEP dots and in forward guidance. We also find a significant impact of macroeconomic news on market participants' expectations of time to lift‐off. These results are consistent with forward guidance about policy rates and SEP forecasts each contributing to the public's understanding of future Federal Reserve monetary policy and with the conditionality of both forms of communication about future policy rates being understood. We also present evidence that market expectations concerning the time to lift‐off are influenced by the maximum time to lift‐off implied by forward guidance, the SEP, and the economic outlook. An appendix provides the FOMC's forward guidance after each meeting from January 2012 to September 2015 and our interpretation of the implied days to lift‐off.

International spillovers from US forward guidance to equity markets

We quantify the international spillovers of explicit Federal Open Market Committee (FOMC) policy rate guidance used as an unconventional monetary policy tool at the zero lower bound of the policy rate on international equity markets, considering equity indices of both advanced and emerging economies. We find that stimulatory explicit FOMC policy rate guidance announcements at the zero lower bound led to higher equity prices in a number of advanced and emerging economies. Moreover, we find that equity indices of economies with lower sovereign ratings rose by more, consistent with the risk-taking channel of monetary policy.

Reactions of real yields and inflation expectations to forward guidance in the United States

We study the impact of forward policy rate guidance by the Federal Reserve’s Federal Open Market Committee (FOMC) used as an unconventional monetary policy tool at the zero lower bound of the policy rate on real and breakeven US Treasury yield curves. We find that explicit FOMC policy rate guidance announcements led to a significant reduction in real yields at horizons of 2 to 5 years ahead. By contrast, long-term breakeven inflation rates were little affected, suggesting that inflation expectations have remained well anchored, and that explicit FOMC policy rate guidance has not adversely affected central bank credibility.

The Effects of the Federal Reserve's Date-Based Forward Guidance

Between August 2011 and December 2012 the Federal Open Market Committee (FOMC) used date-based forward guidance to help stimulate the U.S. economy and promote its objectives of maximum employment and price stability. Some have argued that the formulation of the guidance that the FOMC used may have reduced interest rates primarily by signaling a weak economic outlook rather than by signaling a more accommodative stance of monetary policy. I examine the impact of the date-based guidance, with the principal goal of discerning the extent to which it altered investors' views of the FOMC's policy reaction function. I show that one seemingly straightforward way to address this question--using estimates of the sensitivity of money market futures rates to macroeconomic data surprises--is confounded by the zero lower bound on nominal interest rates, a point that has more general implications for the analysis of the effects of monetary policy at the zero bound. I demonstrate that the problem can be overcome using distributions of investors' short-term interest rate expectations constructed from interest rate options. Using PDFs constructed from these options, along with survey measures of macroeconomic surprises, I find the date-based guidance led to a statistically significant and economically meaningful change in investors' perceptions of the FOMC's reaction function. This finding is robust to various regression specifications and the use of alternative options contracts and PDF fitting methodologies.

The Federal Reserve's Balance Sheet and Earnings: A Primer and Projections

Over the past few years, the Federal Reserve's use of unconventional monetary policy tools has led it to hold a large portfolio of securities. The asset purchases are intended to put downward pressure on longer-term interest rates, but also affect the Federal Reserve's balance sheet and income. We present a framework for projecting Federal Reserve assets and liabilities and income through time. The projections are based on public economic forecasts and announced Federal Open Market Committee policy principles. The projections imply that for the next several years, the Federal Reserve's balance sheet remains large by historical standards, and earnings remain high. Using the FOMC's stated exit strategy principles and the Blue Chip financial forecasts of the federal funds rate, the projections have the Federal Reserve's portfolio beginning to contract in 2015, returning to a more normal size in 2018 or 2019, and returning to a more normal composition a year thereafter. The projections imply that Federal Reserve remittances to the Treasury may decline for a time, and in some cases fall to zero. Once the portfolio is normalized, earnings are projected to return to their long-run trend. On net over the entire period of unconventional monetary policy actions, cumulative earnings are higher than what they might have been without the Federal Reserve asset purchase programs. To illustrate the interest rate sensitivity of the portfolio, we consider scenarios where interest rates are 100 basis points higher or lower than in the baseline. With higher interest rates, earnings tend to fall a bit more and remittances to the Treasury stop for a longer period than in our baseline projections, while with lower interest rates earnings are a bit larger and remittances continue throughout the projection period.

The Federal Reserve's Balance Sheet: A Primer and Projections

Over the past few years, the Federal Reserve's use of unconventional monetary policy tools has led it to hold a large portfolio of securities. The securities holdings in excess of historical norms have been shown to be putting downward pressure on longer-term interest rates. One question asked is how long this unusual amount of monetary policy accommodation will be in place. Here we provide projections of the evolution of the Federal Reserve's balance sheet that are consistent with public economic forecasts and announced Federal Open Market Committee policy principles to help answer this question. We begin with a primer on the Federal Reserve's balance sheet. Then, with the foundational concepts in place, we present a framework for projecting Federal Reserve assets and liabilities through time. In the projections, the Federal Reserve's balance sheet remains large by historical standards for several years. Our baseline projection suggests that market participants likely do not expect the Federal Reserve's portfolio to return to a more normal size until August 2017, and its composition to return to normal until September 2018. Overall, this suggests that market participants believe that unconventional monetary policy will be in place for some time, likely depressing longer-term interest rates for a number of years.

The Federal Reserve's Balance Sheet and Earnings: A Primer and Projections

Over the past few years, the Federal Reserve's use of unconventional monetary policy tools has led it to hold a large portfolio of securities. The securities holdings in excess of historical norms have been shown to be putting downward pressure on longer-term interest rates. One question asked is how long this unusual amount of monetary policy accommodation will be in place. Here we provide projections of the evolution of the Federal Reserve's balance sheet that are consistent with public economic forecasts and announced Federal Open Market Committee policy principles to help answer this question. We begin with a primer on the Federal Reserve's balance sheet. Then, with the foundational concepts in place, we present a framework for projecting Federal Reserve assets and liabilities through time. In the projections, the Federal Reserve's balance sheet remains large by historical standards for several years. Our baseline projection suggests that market participants likely do not expect the Federal Reserve's portfolio to return to a more normal size until August 2017, and its composition to return to normal until September 2018. Overall, this suggests that market participants believe that unconventional monetary policy will be in place for some time, likely depressing longer-term interest rates for a number of years.

Does FOMC News Increase Global FX Trading?

Does global currency volume increase on days when the Federal Open Market Committee (FOMC) meets? To test the hypothesis of excess currency volume on or around FOMC days, we use a novel data set from the Continuous Linked Settlement (CLS) Bank. The CLS measure captures roughly half of the global trading volume in foreign exchange (FX) markets. We find strong evidence that trading volume increases across currency areas on FOMC days during 2003 to 2007. This result holds irrespective of the size of price changes in currency markets and FOMC policy shocks. We interpret the evidence of excess FX trading on FOMC days to be inconsistent with standard models of homogenous agents.

The Effect of Monetary Policy on Economies and Wealth Creation

Intense competition in global labor markets may have quelled inflationary pressures in the United States, but the U.S. Federal Reserve System, the central bank of the United States, must consider the output gap in its policy deliberations. The U.S. Federal Open Market Committee (FOMC) controls overnight interest rates, and it influences the economy through the capital markets and the banking system. Even the wording of FOMC policy announcements can affect the behavior of the markets.

Central Bank Structure, Policy Efficiency, and Macroeconomic Performance: Exploring Empirical Relationships

A ll economists agree that more information is better than less. When people are better informed, they make better decisions, enhancing the efficiency of the economy in allocating resources and improving overall welfare. It would be difficult to find an area of economic life where this line of argument has carried more weight than it has in central banking circles in recent years. The job of central bankers is to conduct monetary policy in order to promote price stability, sustainable growth, and a stable financial system. They do this in an environment fraught with unavoidable uncertainties. But in conducting policy, there is one uncertainty that policymakers can reduce: the uncertainty they themselves create. Everyone agrees that monetary policymakers should do their best to minimize the noise their actions add to the environment. The essence of good, transparent policy is that the economy and the markets respond to the data, not to the policymakers. The result of this agreement is that today we have the nearly universal and immediate public broadcast of all interest rate changes. As everyone in financial markets around the world knows, the Federal Reserve’s Federal Open Market Committee (FOMC) makes a public statement at 2:15 p.m. EST following each meeting. But the first public announcement of a move in the federal funds rate target was made on February 4, 1994, and the regular issuance of a statement became an official feature of the FOMC’s procedures only on January 19, 2000. Before that, it was customary for FOMC policy changes to be communicated to market participants through actions rather than words. There are still people who argue for the efficacy of central bank secrecy in various forms, claiming that surprises are more effective and that even accurate information can be misinterpreted, resulting in undesirable financial market volatility. We think that it is fair to say that these arguments have not been persuasive and that the advocates of policy transparency have won the day. We have been reduced to arguments about the mechanics and exact timing of the release of information. Should the minutes of a meeting be released as soon as physically possible following the meeting, as done by the Bank of England’s Monetary Policy Committee; or should there be a modest delay until just after the following meeting, which is the FOMC’s practice; or is it acceptable to wait for years, as the European Central Bank is planning to do? Is it necessary or advisable for the head of the interest rate–setting body to hold regularly scheduled news conferences? Should the policymakers be required to appear before legislative bodies to provide descriptions of their decisionmaking processes and justifications for their actions? How public should the inputs— forecasts, models, and anecdotes—into interest rate decisions be? All of these questions concern minor issues about the availability of information. As for general principles, we have now progressed to the point where on September 26, 1999, the Interim Committee of the Board of Governors of the International Monetary Fund issued the Code of Good Practices on Transparency in Monetary and Financial Policies: Declaration and Principles (which we will refer to as the IMF Code). As in the case of other standards and codes promulgated under the auspices of the IMF,1 the expectation is that they will be adhered to by all of the countries in the world. We take the statements in the IMF Code to represent a rough version of the consensus on the value of monetary policy transparency. Paragraph 4 of the IMF Code states:

A History of the Asymmetric Policy Directive

T Federal Open Market Committee (FOMC) is the Federal Reserve System’s principal monetary policy-making committee.1 At the conclusion of each FOMC meeting, the Committee issues operating instructions, known as the “directive,” to the Open Market Trading Desk at the Federal Reserve Bank of New York. From 1983 through 1999, these instructions included a statement about the Committee’s expectations for future changes in the stance of monetary policy, in addition to instructions for current policy. The statement pertaining to possible future policy was known as the “symmetry,” “tilt,” or “bias,” of the policy directive. The directive was said to be symmetric if it indicated that a tightening or an easing of policy were equally likely in the future. Otherwise, the directive was said to be asymmetric toward either tightening or easing. Since February 1994, the FOMC has publicly announced changes in current monetary policy immediately upon making them. Before May 1999, public announcements made at the conclusion of FOMC meetings did not indicate whether the FOMC had issued an asymmetric directive. From May to December 1999, however, announcements following FOMC meetings included a statement of the Committee’s expectation about the direction of future policy action, regardless of whether an action was taken at that meeting. This practice attracted considerable attention and much speculation about how to interpret statements about possible future policy changes. The Fed has never provided an official interpretation of these statements. To help clarify its intentions, the FOMC established a subcommittee to review both its policy directive and the public announcement following FOMC meetings. In January 2000, the FOMC announced that the public statement issued at the conclusion of future FOMC meetings will indicate any immediate change in the stance of policy, as well as the Committee’s assessment of the balance of risks between heightened inflation pressure and economic weakness over the foreseeable future. The new language, however, is not intended to indicate the likely direction or the timing of future policy moves. The January 2000 announcement appears to bring to a close a distinct period in the history of Federal Reserve operating procedures. This article will review the history and implementation of asymmetry in FOMC policy directives between 1983 and 1999. Researchers and market participants have suggested at least three interpretations of the FOMC’s use of asymmetric language. One is based on the belief that the FOMC chairman has discretion to adjust the stance of policy by small amounts between FOMC meetings without consulting the full Committee. An asymmetric directive, according to this interpretation, granted the chairman authority to make larger intermeeting policy changes in the direction specified by the asymmetric language than he otherwise was permitted to make. A second interpretation holds that the issuance of an asymmetric directive indicated that the FOMC was more likely to change the stance of policy either before or at the next FOMC meeting, than if a symmetric directive had been issued. Asymmetric language also is thought to have indicated the most likely direction of the policy action. Some observers interpret asymmetry as pertaining just to the intermeeting period, while others contend that asymmetry signaled likely changes in policy at the next FOMC meeting. Before 1994, the FOMC often changed its policy stance between meetings. Since 1994, however, it has rarely done so, suggesting a possible change in the horizon over which asymmetric language pertained. A third interpretation is that asymmetric directives primarily were used to build consensus among the voting FOMC members. For example, if several members of the Committee desired to tighten policy

Secrecy, signalling and the accuracy of expectations during the borrowed reserves operating regime

This paper demonstrates that the information in the undisclosed Federal Open Market Committee (FOMC) policy directive is not completely incorporated into the yield curve one day before FOMC meetings but is incorporated one day after meetings during the borrowed reserves operating regime. These results suggest that monetary policy changes are informally, but effectively, disclosed to market participants through signals from the Open Market Desk. These findings indicate that the legislation before Congress that would mandate the immediate release of the FOMC policy directive would have had little impact on the accuracy of financial market expectations over the sample.

The Information Value of the FOMC Policy Directive under the New Operating Procedures

THE FEDERAL RESERVE S Federal Open Market Committee (FOMC) meets every one to two months to determine its monetary policy objectives over the near-term. At the conclusion of each meeting, the FOMC issues a policy directive to the system's account manager (at the New York Federal Reserve Bank) specifying short-run money growth targets and a federal funds interest rate tolerance range. The policy directive is not disclosed to the public until after the next meeting when a new directive becomes effective. In an earlier paper (O'Brien 1981), evidence was presented suggesting that immediate disclosure of the FOMC policy directives over the period January 1976-June 1979 would have improved the accuracy of market expectations of near-term interest rate levels by no more than minor amounts. In this paper we examine the information value of the FOMC policy directives in predicting near-term levels of interest rates urder the Federal Reserve's revised operating procedures, adopted in late October 1979 but modified in late 1982. In the next section, the interest rate information value of the FOMC policy directive is discussed in terms of a simple money demand and supply model.

FOMC Policy Actions in 1972

The primary policy objective of the Federal Open Market Committee (FOMC) in early 1972 was to provide sufficient monetary growth to facilitate continued real economic expansion in an environment in which administrative controls on prices and wages had been imposed. Late in 1972 the directive of the Federal Open Market Committee specified slower growth of monetary aggregates as the policy discussions indicated an increasing concern for the possibilities of re-emergence of inflationary pressures.