Relying too much on data for decision-making and failing to produce a mid-term outlook, the Federal Reserve is criticized for being at a loss

Although Federal Reserve Chairman Powell has repeatedly emphasized over the past few months that the Fed's interest rate decisions will be based on the analysis of the latest economic data at each meeting, in the past month, there has been significant volatility in U.S. economic data. According to media reports, this has left many market participants dissatisfied, believing that the Fed is unable to provide a clear macroeconomic assessment.

Powell said at the September FOMC press conference, "The actions we actually take will depend on the evolution of the economy."

Analysts believe that while this sounds reasonable, such an approach is quite unusual in the world of monetary policy. Central banks do indeed always focus on the latest economic information, and during brief periods of uncertainty, they rely on this information to guide policy.

However, the media has indicated that the Fed's long-term reliance on this approach has left some investors and economists dissatisfied. They believe it is time for Powell to express more confidence in the economic outlook for the next year or so, which would help the public better understand the direction of Fed policy. With U.S. inflation gradually cooling off, investors critical of Powell hope that he will provide a coherent narrative and discuss the risks and issues related to this outlook.

MetLife Investment Management strategist Drew Matus stated, "The quality of economic data has declined, and most data is lagging. In addition, data revisions could overturn previous assumptions about the health and direction of the economy."

"Relying heavily on data has led to more volatility."

"This is not a good way to make policy decisions."

Over-reliance on Data May Leave the Fed in a Dilemma

Analysis suggests that the direction of the U.S. economy post-pandemic often moves in directions that analysts did not anticipate.

For example, in 2021, the Fed believed that the surge in inflation was "transitory," but it wasn't until November 2023 that inflation dropped below 3%. After the banking industry turmoil at the beginning of 2023, practitioners predicted a recession, but the economy grew by nearly 3% that year.

However, decades of research have shown that monetary policy operates not only through setting interest rates but also through market participants' and the public's expectations of interest rate trends over the next year or so, making accurate predictions crucial. On the contrary, focusing too much on the next few data reports will trap investors in the six-week policy cycle.

Andrew Levin, professor at Dartmouth College and former Fed economist, stated,

"Every monetary economist knows that monetary policy operates through the entire term structure of interest rates, not just the current setting of the federal funds rate. Central banks need to clearly explain how they would adjust the path of the federal funds rate if their baseline forecasts prove to be wrong."

Analysis suggests that recent U.S. labor market reports illustrate the risks of closely relying on data. For example, the employment data for July and August were significantly weak, prompting the Fed under Powell's leadership to initiate a loose policy by starting with a substantial 50 basis point rate cut However, the rebound in job growth in September, as well as upward revisions to the data for July and August, have reduced traders' bets on another significant rate cut. The summer weakness seems to have disappeared, leading some economists to question whether the Fed's actions were too hasty.

Economists: The Fed should have forward-looking expectations

During the press conference after the September meeting, Powell expressed many views on the current economic situation and described how the Fed would address certain risks, but he did not delve too much into the medium-term outlook.

Gregory Daco, Chief Economist at EY, said that Powell's style tends to be more towards "open choices" rather than being skeptical of forecasts, which is somewhat unusual. "He is very candid" in discussing the evolution of the economy, Daco said. However, "a forward-looking perspective would be more useful."

Former Fed Chairman Ben Bernanke also believes that forecasting is crucial because it allows the public and financial markets to understand why central banks react to new data in such a way.

Bernanke, currently serving at the Brookings Institution, wrote this year when evaluating the Bank of England's forecasting methods:

"Central banks regularly publish economic forecasts, which serve multiple communication functions, provide broad rationales for policy decisions, help align private economic decisions and broader financial conditions with the central bank's views, making policy more effective in steering the economy towards the expected direction."

Claudia Sahm, Chief Economist at New Century Advisors, also stated that a clear and structured narrative of economic expectations helps policymakers discuss the risks of the outlook,

"Here, the compactness of the narrative can be helpful, if the baseline scenario is not fully anticipated, then the risks will not be fully discussed."