Especially over the past dozen years or so, the Federal Reserve Open Market Committee's (FOMC) infamous "dot plot" has received widespread criticism. The so-called dot plot is the chart showing where committee members believe (not so much predict) interest rates will be over time.
Although this publicized tool is supposed to provide observers with guidance and transparency from the FOMC, it has scarcely fulfilled these purported functions.
Dot Plot Off the Mark
First and foremost, the dot plot of Fed projections is rather misleading. It supposedly gives some future indication of where monetary policy is going. The source of these projections would seem to be "straight from the horse's mouth," the Fed governors themselves. The only problem is that this isn't how interest rates are determined at all, nor is it what the chart shows.
The federal funds rate is not determined by some average of the individual member's projections, and it really doesn't matter what the various members indicate on the dot plot. These are not commitments that they can be held to, so it seems disingenuous to release this information as if it represents something approaching a commitment in the first place.
The Bloomberg Editorial Board points out, "The first rule of forward guidance is do no harm. The dot plot breaks that rule and needs to go." The markets frequently take the dot plot as gospel and react to any changes in its predictions.
Avoiding the Mess
Another problem with the dot plot is that it hardly some collective representation of the Fed's outlook for the economy. It simply shows all of the different individual perspectives of the central bank's governing members, which often vary wildly. It's what they think the short-term interest rate ought to be, given where they think the economy will be. So, it combines their best guess about future economic conditions (a precarious thing to rely on) with their subjective opinion about where rates should be under those circumstances. In other words, it's not so much a prediction as an opinion based on an underlying guess.
With this in mind, the Fed needs to scrap this pseudo policy tool altogether. It doesn't offer useful information, and in fact can be harmfully misleading. Some Fed officials themselves have admitted as much: San Francisco Fed President John Williams remarked that he had "even thought about dropping out unilaterally from the whole exercise."
The aforementioned editorial board at Bloomberg Business makes a few suggestions of its own that certainly have merit. Perhaps the FOMC could simply delay the release of their dot-plot chart by several weeks to mitigate the potential impact on market behavior.
This all speaks to the overarching problem that the way the Fed communicates with market participants is ambiguous and misleading. If it simply recast what these projections actually are—a snapshot of internal, informal discussions among the central bank's governors rather than an actual picture of policy or expected policy changes—then maybe that would help clear things up.
But we probably shouldn't hold our breath that the Fed will be more transparent any time soon.
The opinions and forecasts herein are provided solely for informational purposes, and should not be used or construed as an offer, solicitation, or recommendation to buy or sell any product.