Waller Warns Rigid Forward Guidance Can Delay Fed Action, Weaken Policy Transmission
By CU Today Staff —
ROME, Italy—Federal Reserve Governor Christopher J. Waller said central banks must focus on current economic conditions rather than historical averages when setting monetary policy, arguing that the unique circumstances following the pandemic demonstrate why "initial conditions" are critical to understanding how policy will affect the economy.
Waller delivered the remarks during a speech at the conference, Challenges for Monetary Policy Transmission in a Changing World, sponsored by the Bank of Italy for a research network initiated by the European System of Central Banks.
Drawing on the Federal Reserve's response to the post-pandemic inflation surge, Waller said many economists incorrectly predicted that aggressive interest rate hikes would trigger a sharp rise in unemployment because they relied too heavily on historical experience. Instead, he said the unusually high level of job openings in early 2022 allowed employers to reduce vacancies rather than lay off workers, resulting in only a modest increase in unemployment as monetary policy tightened.
Waller also cautioned that policymakers should recognize that unusually large economic shocks can change how monetary policy is transmitted through the economy. He argued that traditional economic models, which assume responses are proportional to policy changes, may fail during periods of exceptional volatility because businesses and consumers alter their behavior in ways that shorten the typical lag between policy actions and economic outcomes.
In addition, Waller said forward guidance remains a valuable monetary policy tool but warned it must remain flexible. He pointed to the Federal Open Market Committee's 2020 guidance, saying it ultimately constrained policymakers and delayed interest rate increases as inflation accelerated in 2021. While forward guidance can speed the transmission of policy by shaping market expectations, Waller said it can become counterproductive if it is too rigid or when multiple economic scenarios could require very different policy responses.
Originally reported by CU Today.