Going against Waller? Federal Reserve Board member Waller: Forward guidance is "valuable," but should be flexible.

Divisions within the Federal Reserve regarding the communication methods of monetary policy are coming to the surface.

Federal Reserve Board member Christopher Waller stated on Monday, June 6, at a central bank forum hosted by the Bank of Italy in Rome, that forward guidance remains a valuable policy tool, but needs to be used flexibly. This statement stands in stark contrast to the deliberate downplaying of forward guidance by the new Fed Chair Kevin Warsh.

Monday’s speech shows that Waller acknowledges forward guidance is not suitable in all situations but is unwilling to abandon it completely. The direct implication for the market is: although the Fed has removed forward guidance from its decision statements, there are still internal disagreements among the Fed’s leadership. In the current environment where inflation and employment risks are intertwined and policy direction is highly uncertain, how the Fed communicates with the market will directly affect interest rate expectations and financial conditions.

Meanwhile, Fed officials remain divided on the balance of risks between inflation and employment. Waller noted signs of stabilization in the labor market, allowing the policy focus to shift toward inflation, and pointed out that “the risks have completely flipped,” which will influence policy judgments.

Warsh Leads the Shift, Waller States His Position

Since taking office, Warsh has clearly expressed his opposition to forward guidance.

Last month, during the first FOMC meeting chaired by Warsh, the resolution removed the forward guidance about future interest rate direction. In the post-meeting press conference, Warsh refused to provide interest rate forecasts, citing his disagreement with forward guidance.

Last week, at the European Central Bank’s annual forum held in Portugal, Warsh also stated that financial markets and the real economy operate best when judging situations independently. Fed officials have tended to “feed signals” to the market in the past, which may be reasonable during crisis periods, “but is not suitable for the current environment.”

Waller, however, made it clear he does not want to abandon the tool of interest rate guidance. He said:

“I have always believed that forward guidance is a valuable tool; at times it significantly enhances policy effectiveness and will continue to play a role in the future. But forward guidance is more an art than a science, and sometimes it impedes policy-making rather than helping it.”

Effective Periods: Lessons from the Pandemic Inflation Cycle; Ineffective Periods: Lessons from ‘Tied Hands’

Waller cited Autumn 2021 as an example to argue that forward guidance under specific conditions can significantly accelerate policy transmission. At that time, the FOMC signaled tighter policy to the market; even though the Fed did not hike rates until March 2022, the yield on two-year US Treasury notes rose by nearly 200 basis points from September 2021 to mid-February 2022.

According to reports, Waller noted that this increase is equivalent to shortening a normal 12-24 month policy lag by about six months. “When forward guidance works, it can more quickly change economic conditions than simply adjusting the policy rate,” he said.

However, Waller also acknowledged clear limitations of forward guidance. From 2020 to 2021, the Fed signaled that rates would remain unchanged for some time, but inflation then surged rapidly. In retrospect, this statement instead constrained the FOMC’s actions, causing an unnecessary delay in rate hikes. Waller bluntly said that overly rigid forward guidance “eventually tied the hands of the FOMC in 2021.”

He also pointed out that when multiple economic scenarios are equally probable and the policy path is hard to determine, forward guidance also fails to play a role.

Waller likened this situation to approaching a yellow traffic light—drivers either stop and wait or speed through, but cannot “stop in the middle of the intersection” as a base plan. “You can't simply take a weighted average of scenarios as a ‘base forecast’ for forward guidance,” he said.

Forward Guidance vs. Reaction Function: Two Distinct Concepts

In his speech, Waller emphasized the conceptual difference between forward guidance and reaction function, which also provides an analytical framework for current policy communication disputes.

He defined reaction function as a framework conveying how policymakers will respond to economic shocks to the market—“Give me the data, plug it in, and I’ll tell you what I’ll do”; while forward guidance is declaring to the public and markets, before receiving the data, where policy will or might go. “These are two completely different operations,” Waller said.

He stated that as long as a central bank’s reaction function is clear and fully understood by the market, policy officials actually need not say much. “If your reaction function is unclear and the market doesn't understand, then you need to speak up.” He emphasized that clearly communicating policy targets and how data is incorporated is an effective means to reduce uncertainty.

Labor Market Stabilizes, Risk Profile Shifts

At the macro level, Waller believes the current policy environment is undergoing a key shift. He previously supported rate cuts in 2025 to stimulate employment, but on Monday stated that signs of stabilization in the US labor market allow the Fed’s policy focus to shift toward inflation.

“The risks have completely flipped,” Waller said, “This changes the way you think about policy direction.”

It is worth noting that Fed officials kept rates unchanged last month, but rising inflation to its highest level since 2023 has increased expectations for hikes.

Last month’s post-FOMC dot plot showed that among 18 Fed officials providing rate forecasts, nine—half—expected at least one rate hike this year. Against this backdrop, the subtle divergence between Waller and Warsh in policy communication may have substantive implications for market interpretation of the Fed’s next steps.

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