How Farsighted Is the FOMC?
The most difficult problem facing monetary policymakers results from the long and variable lags in monetary policy's impact on the economy. The full effect of an interest rate change today is not realized for several quarters, so monetary policymakers must be forward-looking. Yet, it is difficult enough to interpret how the economy is doing now, let alone forecast how it will be performing one year hence. This uncertainty hinders the ability of policymakers to offset future fluctuations with current actions. Even so, the lags leave central bankers no choice but to react to their expectations about the future.
This article examines the extent to which the Federal Open Market Committee (FOMC) reacts to forward-looking data. It is shown that the FOMC does look into the future, basing its decisions on expectations about the economy at least as far as a year away. The effects of forecast uncertainty on the farsightedness of the FOMC are also analyzed. It is found that the FOMC's reaction depends on the relative uncertainty across forecast horizons, which can change over time.