What is the Federal Reserve's dot plot: Yahoo U

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Since 2011, the Federal Reserve has published a chart known as the “dot plot,” which maps out policymakers’ expectations for where interest rates could be headed in the future.

The dot plot serves as a guide for financial markets, which tend to dislike policy surprises from the nation’s central bank.

But the dot plot also runs the risk of sending the wrong message, since forecasts are often wrong.

What is a Federal Reserve dot plot?

Four times a year (March, June, September, and December), the policy-setting Federal Open Market Committee (FOMC) publishes a Summary of Economic Projections (SEP).

The SEP includes forecasts for where key economic indicators like GDP, inflation, and unemployment will be in coming years.

The release also includes the dot plot, which map out each members’ projections for where interest rates will be in up to three years (and over the longer-run).

The dots are not labeled with the person who submitted the forecast, leaving it up to Fed watchers to speculate who made what projection.

The FOMC does not coordinate the distribution of the dots. Members of the FOMC can bring up their forecasts in meetings, but the committee does not jointly describe the shape of the dot plot.

How do markets read the dot plot?

Fed watchers like to look at the median forecasts in the Summary of Economic Projections, which the central bank provides for the numerical prints on inflation, unemployment, and GDP.

In the dot plot, the median dots tend to get the most attention, since they represent the most central possible path for policy.

One challenge with looking at the median dot is that it is unclear if a median dot in one given year was submitted by the same Fed official as the median dot in another given year.

By extension, it is also difficult to discern if the median forecasts for inflation, unemployment, or GDP are tied to those median dots.

This means that the “central” forecasts provided in the SEP could be representative of no one on the committee.

Why did the Fed invent the dot plot to begin with?

In the aftermath of the 2008 financial crisis, the Federal Reserve slashed interest rates to near zero and bought trillions of dollars in U.S. Treasuries and agency mortgage-backed securities.

The unprecedented degree of monetary stimulus had markets in the dark about when the Fed would ever raise interest rates again. As a tool to offer more forward guidance to markets on its next moves, then-Fed Chairman Ben Bernanke and soon-to-be Fed Chair Janet Yellen invented the dot plot.

Is the dot plot accurate?

As an invention of 2011, the dot plot has not been around all that long. But the post-crisis episode gives one test for how the dots were able to communicate liftoff from near-zero rates.

Projections published in 2013 and 2014 forecast interest rates rising much faster than the Fed ended up pacing at.

Even after the Fed kicked off its first rate hike in December 2015, forecasts remained unreliable. Projections from the December 2015 meeting showed the median Fed official expecting four rate hikes in 2016.

There would be only one rate hike that year, in December.

The dot plot got better at forecasting rate moves once the Fed steadied its hiking cycle, but the U.S.-China trade war and the COVID-19 crisis again backed the Fed to near-zero rates.

With the dot plot’s shaky record on predicting liftoff, Fed Chairman Jerome Powell is again de-emphasizing the predictive power of the dot plot.

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