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July/August 2008, 
Vol. 90, No. 4
Posted 2008-07-01

Economic Projections and Rules of Thumb for Monetary Policy

by Athanasios Orphanides and Volker Wieland

Monetary policy analysts often rely on rules of thumb, such as the Taylor rule, to describe historical monetary policy decisions and to compare current policy with historical norms. Analysis along these lines also permits evaluation of episodes where policy may have deviated from a simple rule and examination of the reasons behind such deviations. One interesting question is whether such rules of thumb should draw on policymakers’ forecasts of key variables, such as inflation and unemployment, or on observed outcomes. Importantly, deviations of the policy from the prescriptions of a Taylor rule that relies on outcomes may be the result of systematic responses to information captured in policymakers’ own projections. This article investigates this proposition in the context of FOMC policy decisions over the past 20 years, using publicly available FOMC projections from the semiannual monetary policy reports to Congress (Humphrey-Hawkins reports). The results indicate that FOMC decisions can indeed be predominantly explained in terms of the FOMC’s own projections rather than observed outcomes. Thus, a forecast-based rule of thumb better characterizes FOMC decisionmaking. This article also confirms that many of the apparent deviations of the federal funds rate from an outcome-based Taylor-style rule may be considered systematic responses to information contained in FOMC projections.