The biggest flaws in Fed statements — according to an economist who used to write them

Economy

The Federal Reserve is set to release another policy statement later on Wednesday, explaining its view of the US economy.

It will likely be about 500 words long.

Just the length is a problem for the Fed's key means of communicating with markets, according to Vincent Reinhart, chief economist at Standish Mellon Asset Management, the fixed-income investment boutique of BNY Mellon Asset Management.

The first-ever Fed statement released right after a policy meeting, was issued on February 4, 1994. It was three paragraphs and 99 words long.

Reinhart spent 24 years on staff a the Fed, and for six of those he was secretary and economist of the Federal Open Market Committee. That meant he helped draft the statements on policy decisions.

"I'm proud to say that when I was drafting the FOMC statements, you needed a high school diploma to understand them," he told Business Insider on Tuesday. "Now you need a postgraduate degree."

The statement's length is problematic because investors have become ultra-sensitive to every word change. Fed statements are torn apart for any sign that might indicate a change in thinking — even if small.

That in turn has made the Fed hyper-sensitive about how changes to the language will be recieved.

So, it is reluctant to do anything to the statement's wording or structure.

"I don't think that a reasonable description of the economy, done eight times a year over the last two years, would have stayed so unchanged," Reinhart said. "And that's because they are worried about their communications."

The statement is so predictable that some economists publish mock-ups containing their predicted changes. These are rarely that far off the mark.

Reinhart also does not think the dot plot works — or ever worked — as a communication tool. The graphic shows where each voting FOMC members thinks the fed funds rate should be at the end of the year for the next few years and in the longer run.

"That is something that makes you think more about the differences across people rather than the commonalities across the group," Reinhart said.

Other critics note that markets interpret the dot plot as the Fed's firm forecast for interest rates, even though they really reflect an expectation for where rates would likely be.

Reinhart said that Fed guidance works best when it's conveying what the Fed would not do, not what it's likely to do. That vastly reduces the odds that the Fed has to lower its forecasts later, or disappoint markets.

Source BusinessInsider