Submitted by Jeffrey Snider – Alhambra Investment Partners
The Federal Reserve Bank of San Francisco, Janet Yellen’s old institution, has made a habit of breaking with orthodox trends and actually citing and disclosing deficiencies in economic study. In its latest effort, the bank channels a bit of Stanley Fischer and states the obvious, or what everyone else has known for a long time:
Over the past seven years, many growth forecasts, including the SEP’s [Summary of Economic Projections] central tendency midpoint, have been too optimistic. In particular, the SEP midpoint forecast (1) did not anticipate the Great Recession that started in December 2007, (2) underestimated the severity of the downturn once it began, and (3) consistently overpredicted the speed of the recovery that started in June 2009.
The timing of such a statement is almost too perfect, as if there were some turf war being waged within the bowels of the academic apparatus supporting the FOMC’s policymaking efforts. As you may have heard, the FOMC and its SEP has made another set of very rosy projections upon which they want the whole world to believe they will be adjusting policy. It seems at least a bit odd for FRBSF to release a study right now detailing how the Fed’s economists have been too overly and consistently sanguine going back to at least 2007.
Further, the main emphasis about the implications of all this relate to monetary policy itself. Perhaps this is, like Bernanke’s final year, an attempt to get Congress and the fiscal side to “do something” as monetary policy just isn’t effective, or at least as much as the models have been projecting.
According to the SEP, “each participant’s projections are based on his or her assessment of appropriate monetary policy.” A possible explanation for the SEP’s prediction of a rapid catch-up to potential GDP after 2009 is that participants overestimated the efficacy of monetary policy in the aftermath of a so-called balance-sheet recession…The SEP’s overprediction of the speed of the recovery could also be linked to other factors. These include possibly underestimating the damage to the economy’s supply side, as evidenced by the downward revisions to potential GDP, or perhaps expecting larger effects from stimulative federal fiscal policy.
The mention of the “damage to the supply side” is extremely important, because it relates directly to actual economic potential; as opposed to the orthodox approach of using some “updated” Phillips Curve methodology of some calculation of full employment consistent with the inflation mandate. This is a process that has led to statistical revisions in the “potential” of the US economy, especially as modeled by the CBO.