The rudder to an invisible hand

Research evidence excerpt

The rudder to an invisible hand

widely seen as skewed to the upside.

Chair Warsh introduced five task forces focused on communication, the balance sheet, data

sources, productivity and labor dynamics, and inflation frameworks. More importantly, he

signaled a shift in policy-making strategy by eliminating forward guidance, arguing that markets

should respond to incoming data, rather than central bank signaling. Indeed, according to

Warsh, market pricing is "probably the most important source of information to guide central

bankers", and some of this information is lost when Fed guidance undermines these signals.

By shelving forward guidance, we think the Fed would give up one of its most powerful tools.

We remain skeptical that the benefits outweigh the costs: while circularity concerns between

markets and central banks are valid, guidance about policymakers’ economic assessments and

their reaction function is essential for shaping expectations and decision-making of financial

market participants, businesses and households. Without guidance, markets risk mispricing

policy intentions, increasing market volatility and complicating policy execution, especially

given that monetary policy works largely through expectations. Beyond volatility in markets, we

fear that an approach where the FOMC takes its cues from financial markets could be

fundamentally destabilizing for policy, especially if markets lack information about the Fed's

intentions.

Following the meeting, we revised our policy outlook to assume that the Fed holds rates steady

through end-2027, reflecting heightened concern about persistent inflation. While our updated

base case is a prolonged pause until inflation convincingly returns toward target, risks still skew

toward hikes.