Van R. Hoisington and Lacy H. Hunt write,
The Federal Open Market Committee (FOMC) has continuously been overly optimistic regarding its expectations for economic growth in the United States since the last recession ended in 2009. If their annual forecasts had been realized over the past four years, then at the end of 2013 the U.S. economy should have been approximately $1 trillion, or 6%, larger.
They go on to say that the Fed has over-estimated the “wealth effect” by which higher asset prices lead to more consumption.
If the wealth effect was as powerful as the FOMC believes, consumer spending should have turned in a stellar performance last year. In 2013 equities and housing posted strong gains. On a yearly average basis, the real S&P 500 stock market index increase was 17.7%, and the real Case Shiller Home Price Index increase was 9.1%. The combined gain of these wealth proxies was 26.8%, the eighth largest in the 84 years of data. The real per capital PCE gain of just 1.2% ranked 58th of 84. The difference between the two was the fifth largest in the 84 cases. Such a huge discrepancy in relative performance in 2013, occurring as it did in the fourth year of an economic expansion, raises serious doubts about the efficacy of the wealth effect
Let me try to put on a Scott Sumner hat and speak for him. If he reads this, he can correct me.
1. If the Fed under-forecasts nominal GDP (NGDP) in one quarter, than it ought to try raise its target for NGDP in subsequent quarters. That is, it should engage in level targeting, not simply stick to a growth-rate target after a forecast miss.
2. The Fed should use market forecasts rather than rely on a model to forecast. Ideally, we would have NGDP futures contracts. But in their absence, other nominal market variables, such as the spread between non-indexed and indexed bonds, can be helpful.
3. Wealth effect, shmealth effect. Who cares what particular component of the Fed model caused it to underpredict NGDP? Given (1) and (2), there is no good excuse for the Fed missing its targets by such a large cumulative amount.
4. The period 2008-2014 is the mirror image of 1969-1979. In the 1970s’, the Fed consistently under-predicted NGDP, with the result that monetary policy was too loose. In the recent episode, the Fed consistently over-predicted NGDP, with the result that monetary policy was too tight.
Remember that when I take off my Scott Sumner hat, I reject macroeconomics altogether in favor of PSST.
I think your point 4 would benefit from some rework – as the Fed wasn’t targeting NGDP (growth or level) during those periods, its predictions of NGDP during those periods aren’t directly relevant.
Serious doubts about how they understand the wealth effect which behaves nothing at all like their naive conception.
PSST is self evidently always correct because if something is not sustainable and specialized, it is not there to be counted.
I think of it in any number of analogies.
Economics will be occupied with mathematical aggregate modeling until they have applied the highest level math to exhaustion or people just get bored with it. It will even survive massive failures because the research program itself is not played out.
Newsrooms seek out stories with legs that go on-and-on until they peter out or people get bored. Then they move on to the next relatively sustainable story. I first and foremost think the bias of the news is this impulse to make a meal out of it- this is why the slow-as-molasses legal system and the news are like peas in a pod.
Etc.
Didn’t they save us from depression? How could they have underestimated the possible range if outcomes? Mild soft-landing depression?