Central Bank Communication and Disagreement about the Natural Rate Hypothesis

Abstract

The Federal Open Market Committee (FOMC) publishes participants' estimates of the natural rate of unemployment (u*) in the Summary of Economic Projections. About half of professional forecasters use the natural rate of unemployment to forecast. I document a divergence between FOMC participants' and private forecasters' estimates of u* beginning in 2009, when private forecasters revised their estimates of u* up substantially in response to high unemployment, missing disinflation, and the skill mismatch narrative that dominated the financial press. FOMC participants did not revise their estimates up as much because their staffs' research found little evidence of skill mismatch. I examine how fundamental disagreement about the natural rate hypothesis and u* has interacted with the Committee's use of communication to influence private sector expectations at the ZLB. Forecasters' reported estimates of u* are model-consistent, and those who do not use u* have higher and less anchored inflation expectations. Higher private sector estimates of u* are associated with lower credibility of threshold-based forward guidance.

Keywords: central bank communication, Federal Reserve, Summary of Economic Projections, forward guidance, expectations, natural rate of unemployment, missing disinflation, survey data, disagreement

JEL Classification: E52, E58, E43, D83, D84