After each Federal Reserve meeting, market analysts, desperate to divine future monetary policy, scrutinize every aspect of the central bank’s public statements—including its “dot plot,” released four times a year, which charts Fed board members’ expected range of interest rates several years into the future. Since the Fed controls those interest rates, the dot plot is intended to make the board’s thinking more transparent to the public. The Fed, in other words, wants to signal its plans to the market, avoiding costly surprises and needless volatility.
Economic research shows that the market’s expectations about future interest rates are extremely powerful in shaping the way policy works—perhaps as powerful as the Fed’s setting rates itself. For the dot plot to deliver these benefits, though, the Fed must have some idea of what the future holds and the intention to follow through on its own plans. The last few years have undermined both premises. All the dot plot really does is make plain that many economic variables are entirely unpredictable and that the Fed does not have a better crystal ball than anyone else. This ultimately lessens the Fed’s credibility and makes the bank less powerful.
The Fed has published the dot plot since 2012. At its inception, the tool marked the culmination of an intellectual fashion in monetary economics. In the Alan Greenspan era (1987–2006), the Fed chair shrouded his thinking in mystery, giving him a magical aura. But Greenspan’s successor Ben Bernanke, a brilliant scholar of monetary policy, took a humbler approach. Transparency was his signature policy style; he adopted an explicit inflation target and tolerated, even published, internal dissent among board members. The dot plot was part of this new openness.
A primary tension in monetary policy exists between rules and discretion. If a central bank adopts a discretionary policy, it does not operate from an explicit preestablished plan but instead responds to events as they unfold, based on data. A central bank operating with a discretionary policy can occasionally shock markets by, say, allowing higher inflation than markets expected, hoping to reduce unemployment. A discretionary approach can have a major impact on the economy, as firms have baked their expectations in to their pricing, wage increases, and investment plans. If a central bank keeps surprising markets, moreover, it loses credibility; if, say, it announces a rate-hike plan to curb inflation and the market doesn’t believe that it will carry it out, the central bank may end up with higher inflation than it wanted, along with a diminished ability to influence the economy. By contrast, a central bank following a rules-based policy may find specific moves that it makes less powerful; but the approach ensures market credibility and stability and is, overall, a better alternative.
After the Great Recession, smart people at the Fed figured that they could get the best of both the discretion- and rules-based approaches. The Fed adopted a long-term rule to keep interest rates low—they had gone to zero after the financial crisis—with some short-term discretion. And part of this was mapping out their future plans, with the dot plot. The dot plot was both a prediction (where the Fed thought that the economy was heading) and a promise (how it would act in the future).
It all seemed to work, at least if interest rates stayed near zero. But economic turmoil—specifically, the return of inflation—exposed the weakness of the Fed’s compromise. The dot plot from December 2021 did not anticipate the federal funds rate going much higher than 2 percent by 2023; it now stands above 5 percent. The promise wasn’t held. The plot also predicted that inflation would be back down to 2 percent by now. It remains over 3 percent. The prediction failed.
Apollo Global’s chief economist Torsten Slok published a chart showing how the Fed’s forecasts on both inflation and interest rates consistently miss their target. The central bank’s commitment to low rates may be one reason that it was so slow to act when inflation first heated up. Between bad forecasts and slow response, the Fed suffered a blow to its credibility from which it may take years to recover.
The Fed should stop publishing the dot plot, which proves only that the economy is unpredictable while shattering the illusion that the Fed knows something that the rest of us don’t.
Photo by Yasin Demirci/Anadolu Agency via Getty Images
