Since it began announcing meeting decisions in 1994, the Federal Reserve has made an ever- increasing volume of information available, including detailed economic and interest rate forecasts, meeting transcripts, post-FOMC news conferences, and intermeeting speeches. The main rationale for these efforts is the idea that the public’s perceptions of monetary policy—including its goals, framework, and future course—play a crucial role in determining policy effectiveness for the macroeconomy. Perceptions may also drive long-term rates – which matter for example for mortgage lending – by affecting the risk premium component in long-term interest rates. A substantial body of theoretical research therefore supports the notion that perception is no mere response to policy—perception also shapes policy.
However, measurement of these perceptions and how they vary over time has been challenging. While monetary policy frameworks—which include various policy tools applied at different levels and at different times—are relatively complicated, they are often described more simply via a policy rule. Researchers have typically relied on macroeconomic time-series data to analyze monetary policy rules, but these data do not capture perceptions and do not account for high-frequency changes in a policy’s parameters.
As a result, important gaps persist between what we know about the public’s perceptions of the Fed’s monetary policy rule, and how those perceptions change in response to policy actions.
To address this gap, the authors develop new estimates of the perceived monetary policy rule each month from forecaster-level Blue Chip Financial Forecasts (BCFF) data. Because these forecasters are professionals, this represents the perceived monetary policy rule of sophisticated economic agents rather than households. Please see the working paper for a full description of the authors’ methodology, but broadly speaking the authors utilize variation across forecasters and forecast horizons to estimate the relationship of Fed funds rate forecasts with inflation forecasts and output gap forecasts (the output gap is the difference between actual and potential output). This allows the authors to estimate the perceived monetary policy rule and to detect parameter shifts at substantially higher frequencies and over a longer historical period than previous work. In other words, they can more closely gauge when shifts in perception occur to infer why they occurred.
Using their new measure, the authors find the following:
Bottom line: The authors’ evidence suggests that changing beliefs about the monetary policy rule can explain such otherwise puzzling phenomena as when long-term bond yields decouple from changes in monetary policy rates, as occurred in 2004-2005. For central bankers, this research (and the promise of future work), offers insights into the role of perceptions and learning about the monetary policy rule, which is especially relevant for the effectiveness of monetary policy during periods when the monetary policy framework is experiencing substantial review.