Wednesday, August 1, 2012
The Fed as Little Orphan Annie
The Federal Open Market Committee met today. The only notable change to their statement was a pledge to "closely monitor incoming information on economic and financial developments" and to "provide additional accommodation as needed to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability." Euro fears are behind these words, but no action for now. The essence of today's FOMC statement is wait-and-see.
But let's zoom out for a moment. The Bernanke Fed has made a significant effort since June 2009, when the NBER judges the recession to have ended, to increase transparency by providing guidance about future policy and macroeconomic forecasts. What is striking, however, is how this transparency has not prevented in the slightest the intellectual dishonesty in ignoring its failure to meet its own goals.
A disparaging but not unfair comparison would be to little orphan Annie. "The sun'll come out tomorrow," Annie sang. "Bet your bottom dollar that tomorrow there'll be sun." The 3-to-4 percent recovery growth we've been long promising will come out tomorrow, the FOMC basically says every quarterly meeting. Bet your bottom dollar that tomorrow there'll be lower unemployment.
The Fed must love tomorrow. Because, as they say, it's always a day away.
What I mean by this is the Fed makes projections, misses them by miles and consistently in the wrong direction, and then doesn't own up to it. They just push back their forecast. The forecasts are not inappropriately optimistic, either -- it's just that the Fed's actions have fallen short, and that there is zero accountability to target the forecast.
Their transparency, however, allows us to demonstrate thoroughly the extent of this failure.
Immediately below are two graphs of the FOMC's published forecasts of percent annual real GDP growth. I've graphed all forecasts made from June 2009 to June 2012 for the years 2010-2014. They show the same data, but in two different ways. In the first graph, period forecasted is on the horizontal axis and the value forecasted on the vertical axis. Therefore, each line represents a forecast curve made at a time denoted in the legend. What you'll notice is that the forecast curves "walk" to the right. This is the signature in the data of the little orphan Annie Fed -- the Fed getting a bad number, pushing out the forecast of good times until tomorrow, but doing nothing that would actually get the economy to the desired end, such that the Fed gets another bad number the next quarter, and so on.The second graph, again of percent annual real GDP growth, puts the time the forecast was made on the horizontal axis and the value forecasted on the vertical axis. Therefore, each line represents the forecast for real GDP growth in a given year, much like you'd see in a time-series graph of a stock's share price. Again, you see what I would like to call the "Annie effect": the Fed doesn't see any problem making optimistic forecasts to whose realization it would never commit when those outcomes are further off, but as time passes and it becomes increasingly clear that those forecasts won't happen, it writes down its estimates. Hence the five sequential plunges; I'd contend that the 2012, 2013, and 2014 forecasts are all still significantly higher than what will happen.We just saw the Annie effect in real GDP growth, but it's even more pronounced and more costly in the unemployment rate, graphing all forecasts made from June 2009 to June 2012 for the years 2009-2014. The two graphs below work the same as the first and second graphs above.
This graph shows that the Fed has consistently anticipated a faster fall in the unemployment rate and later revised their estimates to reflect higher actual unemployment -- you see again the "walking outward" of the forecast paths of the unemployment rate.This graph shows the Annie effect in the other fashion, showing the time series of the forecasted values for unemployment in given years, and how they track consistently upwards over time.It's one thing to say that the Fed understands and accepts that without real action and policy commitment, real GDP growth will be slow and the unemployment rate will remain high. That would be an intellectually legitimate, though I think economically inappropriate, course for policy, especially if the marginal cost of NGDP growth at this point is perceived as high. It's another thing to pretend that the sun is coming out tomorrow, use that as a pretense for no further action, and then dodge responsibility when the real economy fails to improve. What the Fed has done for the last three years makes a mockery of central bank credibility and accountability and avoids true consideration of policy required to meet the dual mandate.