The FOMC’s Enhanced Transparency Reveals Old Paradigm Pessimism

Transparency is a good thing if you like what it lets you see. In the making of monetary policy, that's a big if. Transparency is Mom and Apple Pie these days, but I think the exuberance is, if not irrational, at least excessive. This little rhyme, repeated from my previous posting, reflects my skepticism:

Transparency is a current central banker cause
But it reminds me too much of sausages and laws
I think translucence, like my shower door, is a good compromise
It lets in the light, but keeps out the flies.

If you must forecast, I've learned, it's best to do it often. Increasing the number of FOMC member forecasts from two to four per year was a clever idea. It is more transparent, but it's also easier. You get to adjust an errant forecast twice as often and in half the time.

The FOMC's mistake, in my opinion, was extending the forecast horizon out to three years.  Given each member forecaster's assumption of "appropriate monetary policy," however they define it, three years is long enough for policy to do all that policy can do. It's long enough for initial adverse conditions to be overcome. What's left in that third year forecast is the FOMC's implicit view of the best it can do, or the limits of the economy — it's capacity to produce without causing inflation to accelerate. I call that a mistake in part because their view, revealed by their latest forecast, is so dismal. I can't find a Goldilocks economy anywhere on their horizon.  

Their range of forecasts for real GDP growth in 2010 is a puny 2.2 to 2.7 percent, with a central tendency of 2.5 to 2.6. That growth rate is assumed to produce an unemployment rate of 4.7 to 4.9 percent, above the current rate, and a core PCE (personal consumption expenditure) inflation rate of 1.6 to 1.9 percent.  The core PCE forecast is about the same as today, although they also have the number for the headline rate the same, which is lower than the current number, but that doesn't mean food and energy prices come back down. It just means they aren't expected to continue rising as fast.  If 2010 is Goldilocks, as Lyle Lovett might describe her, she's ugly from the front.

A 2.5-2.6 percent growth rate in 2010, which can be interpreted as the FOMC's  estimate of the economy's growth potential, can be expressed as the sum of labor force growth (hours worked) and productivity growth (output per hour worked).  The labor force typically grows about 1 percent per year.  That means that productivity growth is expected to slow to around 2 percent per year.  Why so low?  As I used to say prior to the late 1990's productivity revolution, trees grow faster than that.

The natural rate of unemployment implicit in the forecast has risen to almost 5 percent. Since both growth and unemployment are currently more favorable than their 2010 growth and unemployment estimates, it's no wonder the FOMC is concerned about inflation.

These numbers mean we're already over the speed limit for monetary policy. If they try to enforce such a low speed limit, they could create a self-fulfilling prophecy. That possibility, to me, calls into question of public forecasts by policymakers.  The path they've outlined is one of managing slack in the economy to hold down inflation.  I'd rather see them control inflation through growth — disinflationary growth.

We had this debate in the late 1990's, and the optimists won out (until June 1999).  Because of that, an artificially low speed limit wasn't enforced, and the result was faster real growth, faster employment growth, lower unemployment, and lower inflation.  I hope we aren't back to underestimating the U.S. economy.