Waller urges focus on initial conditions and flexible forward guidance

Governor Christopher J. Waller told a policy audience that the Federal Open Market Committee must treat the current state of the economy as the primary driver of monetary policy, not historical averages. His comments bind the Committee's future deliberations on rate setting and communication.

Waller highlighted the 2022 labor market, noting that the ratio of job vacancies to unemployed workers was 2 - a level never seen before. He argued that, because employers reduced vacancies rather than cutting staff, unemployment rose only modestly despite aggressive tightening. The speech cites his May 2022 prediction and related FEDS Notes as evidence.

He warned that large, rapid policy shocks behave non-linearly. Citing the Lucas critique and research on rational inattention, Waller said that a "doubling of an interest rate shock" does not simply double its effect. Instead, big shocks can shorten the usual 12- to 24-month lag, as firms adjust pricing behavior more quickly.

On forward guidance, Waller contrasted two episodes. In September 2021 the Committee signaled upcoming tightening; the two-year Treasury yield rose nearly 200 basis points, effectively shaving about 6 months off the typical lag. By contrast, the September 2020 guidance that rate hikes would wait until inflation was "on track to moderately exceed 2 percent for some time" limited the Committee's ability to act as inflation rose above 2 percent in 2021.

Waller concluded that forward guidance can accelerate transmission, but only if it remains adaptable. When guidance is too rigid, it may hinder policy, and in some scenarios it may be best omitted entirely.