Greg Ip

Articles by The Economist’s U.S. Economics Editor

The Fed’s forecasts: Serial disappointment

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Jun 23rd 2011, 20:31 by G.I. | WASHINGTON

THE Fed attracted attention this week for downgrading its forecast not just for this year, but for 2012, as well. More striking is how often it does this. As my nearby chart shows, the Federal Open Market Committee has repeatedly ratcheted down its forecasts of out-year growth. The latest downward revision is particularly large, and in keeping with the pattern: when the current year disappoints, they take a bit out of the next, as well. (The chart shows all their forecasts since early 2010 except two, for the sake of simplicity.)

This is not because the Fed thinks the economy’s potential has diminished: long-run growth forecasts remain the same and they’ve raised their view of the long-run unemployment rate just a smidgen.

I asked Ben Bernanke, the chairman, at his press conference, why, if the restraints on the economy are temporary, the FOMC lowered its medium-term outlook. He replied:

Part of the slowdown is temporary, and part of it may be longer-lasting. We do believe that growth is going to pick up going into 2012 but at a somewhat slower pace than we had anticipated in April. We don’t have a precise read on why this slower pace of growth is persisting. [S]ome of the headwinds that have been concerning us, like … weakness in the financial sector, problems in the housing sector, balance sheets and deleveraging issues…may be stronger or more persistent than we thought. And I think it’s an appropriate balance to attribute a slowdown partly to the identifiable temporary factors, but to acknowledge a possibility that some of the slowdown is due to factors which are longer-lived and which will be still operative by next year.

Judging by my email, Wall Street was disappointed with his answer. “I’m not sure why they wouldn’t know why they took their 2012 growth forecasts down,” grumbled one. “I think they are just feeling a bit beaten down by having been above consensus and proven wrong so far,” said another. In other words, they’re groping.

Maybe. One way you know Mr Bernanke is still at heart an academic, not a pol, is that he hates to say “no comment”. He always tries to answer the question rather than recite a talking point (an unusual and refreshing quality in this town). His admission of ignorance reflects genuine puzzlement with the economy’s failure to reach what he likes to call escape velocity.

Mr Bernanke does not need lessons about the painful deleveraging that follows crises. His pioneering work with Mark Gertler on the Great Depression introduced the “financial accelerator”, the mechanism by which collapsing net worth crushes the real economy. This concept has been rechristened the “balance sheet recession” by Richard Koo. Stephen Gordon admits he is new to the term and notes (with some nice charts contrasting America with Canada) “it’s not pretty”. (HT to Mark Thoma). Yet until now Mr Bernanke seemed to think America had learned enough from both the 1930s and Japan to avoid either experience. Reminded by a reporter for Yomiuri Shimbun that he used to castigate Japan for its lost decade, Mr Bernanke ruefully replied, “I’m a little bit more sympathetic to central bankers now than I was 10 years ago”.

He did, however, make the important point that he stands by his view of a decade ago that the Bank of Japan then, and the Fed now, could, if it wanted, prevent deflation, both through the direct effect of monetary policy and its impact on expectations.

This has led to the gloomy consensus that because the risk of deflation has receded since QE2 was rolled out last August, no QE3 will be forthcoming. Tim Duy thinks that “If anything, the FOMC statement shifted in a slightly hawkish direction”. Paul Krugman’sverdict: “it declares its work done”. My colleague shares this verdict, and their disappointment.

I think they’re wrong. I detected signals that while the bar to QE3 remains high, it’s dropped a bit. Yes, Mr Bernanke said the case for QE3 was weaker than for QE2 last August, because deflation is less likely and job growth has been better. But he also said:

We have an awful lot of uncertainty right now about how much of the slowdown is temporary, how much is permanent; so that would suggest, all else equal, that a little bit of time to see what’s going to happen…would be useful in making policy decisions.

I read in this a willingness to act if growth continues at its current, trend-like pace of 2.5% to 3% rather than accelerating. It is true that deflation is not imminent. But that is not the same as saying inflation is a problem. The FOMC’s own statement, and its forecasts, see core inflation as more likely to stabilise below, rather than above, its informal, 2% target. By itself that is not sufficient reason to move, but combined with continued disappointment on growth and unemployment, it would be.

Mr Koo has argued that quantitative easing cannot help in a balance sheet recession; only fiscal policy can. Does Mr Bernanke secretly agree? He may believe as strongly as he did a decade ago that sufficiently aggressive monetary policy can prevent deflation, but not that it can create enough demand to restore full employment. This does not rule out QE3; it only means it will be pursued with less hope about the results than a year ago.

 The original post is linked here.

Written by gregip

June 23, 2011 at 12:30 pm

Posted in Uncategorized

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