Policy Error
A central-bank decision (or non-decision) that subsequent data reveals to have been miscalibrated — either over- or under-tightening relative to optimal.
Definition
Policy errors come in two flavors: hawkish errors (over-tightening into recession) and dovish errors (under-tightening, letting inflation embed). Markets price the probability of each, and the curve shape often signals which the consensus expects.
Historically, the most damaging errors have been late dovish errors (Burns 1970s) and late hawkish errors (BoJ 1990).
Why it matters
Policy errors drive the largest macro moves of a cycle. Recognizing one early — by reading curve, credit, and FX signals — is a primary source of macro alpha.
Worked example
December 2018: Fed hiked into a slowing economy with credit spreads already widening. The Powell pivot in January 2019 effectively conceded a hawkish error; equities ripped.
Frequently asked
How do markets signal a policy error?⌄
Are dovish or hawkish errors worse?⌄
Can policy errors be avoided?⌄
What's the standard playbook for trading a policy error?⌄
Related terms
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