Chastened over forecasting errors, Fed officials will be less likely to tip their hands on how they see the future
One of Wall Street’s favorite pastimes is trying to discern hidden meaning in language tweaks from Fed officials. But Bernanke, the central bank’s former chairman, thinks doing so under current conditions will only lead investors astray.
In part, that’s because most Fed officials have been wrong on their economic forecasts over the past several years. They anticipated that economic growth would be stronger, while both the unemployment rate and the natural level of interest rates would be higher.
Chastened over their forecasting errors, Fed officials will be less likely to tip their hands on how they see the future, both in terms of growth and whether they will hike rates.
“It has not been lost on Fed policymakers that the world looks significantly different in some ways than they thought just a few years ago, and that the degree of uncertainty about how the economy and policy will evolve may now be unusually high,” Bernanke wrote this week in his most recent blog post for the Brookings Institution, a think tank he joined after leaving the Fed in 2014.
“In general, with policymakers sounding more agnostic and increasingly disinclined to provide clear guidance, Fed-watchers will see less benefit in parsing statements and speeches and more from paying close attention to the incoming data,” he added.
Bernanke’s successor, Janet Yellen, long has professed that the Federal Open Market Committee over which she presides is “data dependent.” However, it’s often been unclear which data Yellen and her colleagues watch, as unemployment has fallen well below the Fed’s target level, the economy has managed steady if less-than-stellar growth, and stock market levels set new records, spurring worries of asset bubbles.
Bernanke examined Fed long-run forecasts starting in 2012 in three areas: output growth, unemployment and the “terminal” fed funds rate, which is what the Fed uses to guide the path of interest rates and reflects where the rate should be in order to promote stable growth. He found that FOMC members have had to scale down consistently.
Source: Brookings Institution
The Fed’s expectations that the unemployment rate would be higher could be as much a function of the measure’s dynamics: A significant portion of the decline has come from a generational low in labor force participation, which translates into a lower jobless number.
For investors, Bernanke believes the Fed’s realization that it has been too optimistic about growth, and that as a result policy is probably less accommodative than it appears, is likely to lead to a reluctance to raise rates. That comes even though “the current policy is not as stimulative as previously thought,” he said.
“With a shorter distance to travel to get to a neutral level of the funds rate, rate hikes are seen as less urgent even by those participants inclined to be hawkish,” Bernanke wrote.
“In particular, relative to earlier estimates, they see current policy as less accommodative, the labor market as less tight, and inflationary pressures as more limited,” he continued. “Moreover, there may be a greater possibility that running the economy a bit ‘hot’ will lead to better productivity performance over time. The implications of these changes for policy are generally dovish, helping to explain the downward shifts in recent years in the Fed’s anticipated trajectory of rates.”
2016 has been a particularly rough year for Fed forecasting.
While raising rates for the first time in more than nine years at the December 2015 meeting, FOMC members anticipated four more hikes this year. However, the market now is betting that there will be none, with the next likely date for a move being June 2017.