Scott Sumner  

Predicting failure

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Lars Svensson has argued that the Fed should "target the forecast", which means they should adjust policy so that their predicted outcome is also their targeted outcome. Information accidentally leaked by the Fed indicates that they are not doing this, rather they are setting policy at a position expected to lead to failure:

All but two of the Fed's 17 policymakers said last month they think rates should rise in 2015. They were divided between whether it would be best to raise rates once or twice this year.

The staff views were less optimistic about the economy than several key policymaker forecasts.

In the projections, which stretched from 2015 to 2020, the staff did not expect inflation to ever reach the Fed's 2.0 percent target. By the fourth quarter of 2020, they saw the PCE (personal consumption expenditure) inflation index rising 1.94 percent from a year earlier.

And the prospects for growth are also quite bleak:

The Fed's staff also took a dimmer view of long-run economic growth, expecting gross domestic product to expand 1.74 percent in the year through the fourth quarter of 2020. The views of Fed policymakers for long-term growth range from 1.8 percent to 2.5 percent.

The Fed goes to great lengths to manage the release of sensitive information. Policymakers and staff avoid making public comments just ahead of policy meetings, and the Fed makes journalists turn in their phones before letting them into a locked room to see a policy statement and prepare news stories just before the interest rate decision is published electronically.

It's not clear why the Fed is planning to raise rates this year. Are they still committed to a 2 percent inflation target? If the U.S. avoids recession, then inflation would have undershot 2 percent during almost the entire 2009-20 expansion. But why? And if we have a recession between now and 2020, how will the Fed avoid the mistakes of the last recession? Recall that in 2009 the U.S. experienced deflation during a period of high unemployment, a clear violation of the Fed's dual mandate.

Congress is now trying to get the Fed to adopt a clearer policy rule. This leaked report makes it clear why more transparency is needed. I've spent my entire life studying monetary economics, and especially the Fed, and yet even I would not be able to explain to an economics student what the Fed is trying to achieve with the forthcoming rate increase.

Comments and Sharing

COMMENTS (6 to date)
Lorenzo from Oz writes:

And so we Downunder give thanks for the RBA.

John Hall writes:

I'm with you completely on this one.

Federico writes:

Occam's razor? Perhaps they won't raise rates? Perhaps there's a similar miscommunication as to the non-beginning of the tapering (i.e., when they didn't taper, even though everybody thought they would)?

MikeDC writes:

Last weekend my extended family here in Belgium asked me if the Fed was really going to raise rates and to explain why, and I had nothing.

I think it boils down to feeling like they "should". But every time they get together and really look at the economy, they realize it'd be stupid. So they say "next time we'll raise rates" and build a bit more pressure on themselves to do it.

It's a completely irrational model of behavior, but I can't find a rational one that fits better.

Scott Sumner writes:

Lorenzo, I agree.

Federico, That would make me question their communication skills.

Mike, I often feel the same way.

Charlie writes:

"The forecasts do not represent the views of the central bankers who set interest rate policy. Those policymakers, many based outside of Washington in regional Fed branches, create their own forecasts, the most recent of which were released on June 17."

I think a more accurate description is that Fed Board staffers think the FOMC will fail.

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