The Biggest Flaws in Fed Statements — Insights from a Former Economist Who Wrote Them

The Federal Reserve is poised to announce a new policy statement later today, outlining its perspective on the US economy. This statement is expected to be approximately 500 words long, which, according to Vincent Reinhart, chief economist at Standish Mellon Asset Management, presents a challenge for the Fed’s primary method of conveying information to the markets.

The initial Fed statement, released immediately following a policy meeting, dates back to February 4, 1994. It was a concise document, consisting of only three paragraphs and 99 words.

Reinhart, who spent 24 years working at the Fed, including six years as secretary and economist for the Federal Open Market Committee, was directly involved in crafting these statements. He remarked, “I’m proud to say that when I was drafting the FOMC statements, you needed a high school diploma to understand them. Now you need a postgraduate degree.”

The increasing length of these statements poses a problem because investors have become extremely attentive to any slight changes in wording. Statements are scrutinized for hints that may signal shifts in the Fed’s outlook, no matter how minor. This has led the Fed to be overly cautious about how its messages are perceived.

Reinhart highlighted that the economy’s description, which has been fairly consistent over the past two years, would likely have evolved more if the Fed had not been so concerned about its communications. The predictability of these statements has led some economists to create mock-ups that closely mirror the expected content, illustrating how minimal deviation is anticipated.

He also expressed skepticism regarding the effectiveness of the dot plot, which displays the projections of FOMC members for the future federal funds rate. Reinhart believes this graphic focuses more on individual discrepancies than on the group’s consensus.

Critics point out that the markets often misinterpret the dot plot as a definite forecast for interest rates, despite it merely reflecting expectations. He asserts that the Fed’s guidance is more effective when it communicates what it will avoid doing rather than attempting to predict future actions, as this approach minimizes the risk of having to revise forecasts downward, or failing to meet market expectations.