Risky Business

In a recent Wall Street Journal interview, Philadelphia Fed President Charles Plosser expressed concerns about the FOMC's "balance of risks" statement, saying that it can "put the committee in an awkward position. Markets often use our balance of risks to infer something about what they think the path of the funds rate is going to be..."

Plosser makes a good point: ideally, the FOMC's statement should communicate a sense as to how the Fed would respond to new information, rather than drop hints about the next change in the target rate. The FOMC's old "asymmetric directive" with its "woulds and coulds" was abandoned precisely because it was widely believed to provide a good forecast of the next rate change. It was hoped that the "balance of risks" formulation would address Plosser's concerns, but clearly it hasn't: instead, it seems to have become a substitute, at least in the minds of market participants, for the "tilt" in the asymmetric directive.

Probably the only way to deal with the problem is to increase the bandwidth of Fed communication. Fedwatchers will always be in the business of forecasting the FOMC's next move, of course. But so long as the FOMC's announcements are accompanied by brief, formulaic statements, Fedwatchers will interpret even the smallest changes in the wording of those statements as a signal of -- or worse, an implicit commitment to -- future target rate changes.