Lift-off Uncertainty: What Can We Infer From the FOMC's Summary of Economic Projections?

When the policy rate is constrained by the zero lower bound (ZLB), inference about central bank behavior becomes more difficult. As a result, despite possible efforts to counteract this effect through more active communication, policy uncertainty tends to increase. In particular, uncertainty about the degree of commitment becomes key. We use standard New Keynesian models subject to the ZLB to quantify the uncertainty around interest rate forecasts provided in the FOMC's Summary of Economic Projections (SEP). The first step involves an assessment of the degree of Fed commitment to provide accommodation for extended periods of time. To that end, we calibrate versions of the models under different assumptions about the degree of policy commitment, and assess which specification provides the best fit to the so-called "SEP dots". We then use the best-fitting specification to construct uncertainty bands around SEP interest rate forecasts, obtained by simulating policy responses to economic developments going forward. Our results suggest that the degree of Fed commitment to low rates for an extended period of time decreased since 2013. The reduction followed a change in FOMC forward guidance, and intensified as Quantitative Easing tapering took place. Quantitatively, our median projection indicates that lift-off will occur in 2015Q2, but there is some risk that rates will remain at zero until the end of 2016.