ByMichael J. Dueker
From the 1980s into the early 1990s, many of the adjustments that the Federal Open Market Committee (FOMC) made to its target for the federal funds rate took place between regularly scheduled meetings. Accordingly, the FOMC adopted language in the directives it issued at meetings to indicate possible policy moves before the next meeting. Since 1992, however, policy moves between meetings have been the exception, as all but two changes in the federal funds target rate occurred at FOMC meetings.
Despite the reduced reliance on intermeeting target changes, the FOMC did not update the language in its policy directive until February 2000, even though it began immediately releasing its policy leanings to the public in May 1999. On Jan. 19, 2000, the FOMC announced that it would begin using new language in the statements made public after its meetings to provide an "assessment of the risks to satisfactory economic performance." The committee now indicates if risks are tilted toward either "heightened inflation pressures" or "general economic weakness."
More broadly, however, the FOMC has adopted new language to place increased emphasis on the long-run goals of monetary policy—stable prices and sustainable economic growth—and less emphasis on the likelihood of an increase or decrease in the fed funds target rate in the near term. On several occasions in 1999, the FOMC found that financial markets showed exaggerated responses to any new data thought to point to higher interest rates if the committee had announced a directive biased toward tightening. One way to see the effect of the announced directives on financial market volatility since May 1999 is to look at expected bond yield volatility as measured in options prices for Treasury bonds. The bond market provides evidence about this question, because uncertainty about the future course of short-term interest rates—such as the federal funds rate—will also be reflected in uncertainty about the future behavior of bond yields.
The accompanying chart shows an index of bond market volatility (the Merrill Option Volatility Expectations Index) for 10 business days before and after each FOMC meeting from May 1999 to November 1999. At the top of the chart, the change in the federal funds target rate and the FOMC's bias are noted for each meeting (+ for a bias toward future tightening and—for a bias toward easing). In this period, bond market uncertainty tended to increase when the FOMC announced a bias toward future tightening. With the new disclosure language, Federal Reserve policy-makers intend to establish a forum for clearly communicating their appraisal of possible threats to the attainment of long-run goals, without putting financial markets on a hair trigger concerning shifts in the likely course of interest rates. At the conclusion of the meeting on Feb. 2, 2000, the FOMC first employed the new language and announced that the risk of heightened inflation pressures predominated in that current "trends could foster inflationary imbalances." Following its meeting on March 21, 2000, the FOMC reiterated concern about the possible emergence of "inflation imbalances that would undermine the economy's record economic expansion."