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Irwin Kellner Archives | Email alerts
Jan. 24, 2012, 12:01 a.m. EST
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By Irwin Kellner, MarketWatch
PORT WASHINGTON, N.Y. (MarketWatch) "” The Federal Reserve has misinterpreted more than once developments that were already underway "” much less those that lay ahead.
At the conclusion of this week's meeting of the Federal Open Market Committee, the Fed is expected to reveal its members' innermost thoughts and expectations about the future. If the early word is correct, the Fed will publish the predictions of senior officials regarding the course of interest rates over the next several years.
Don't bet the ranch that these forecasts will come true. When push comes to shove, the Fed is no better a forecaster than the rest of us. Indeed, it may well be worse.
Take the housing bubble, for example. Just-released transcripts from the Fed's meetings back in 2006 reveal that central bankers had no clue that there was a housing bubble which would lead to a financial crisis.
Yet anyone who followed the course of housing prices and household incomes knew that something was amiss.
After having averaged three times annual incomes for years (and 2-1/2 times in the early 1970s), the ratio of home prices to incomes shot up to five times by 2005 "” and over six times incomes in such bubble markets as those of South Florida, Nevada, New Mexico and Southern California.
As for the Fed and other regulators of mortgage lending, a close examination of the books of the firms under their supervision would have revealed that the only reason many people were able to obtain a mortgage was that it carried a low adjustable rate. Once rates would begin to rise, their monthly payments would, too.
Without parsing every word of these old Fed meetings, I can recall at least two other occasions in the modern era when the Fed failed to realize what was happening.
An embargo by the European Union countries against Iran oil shipments sends oil prices higher. AP Photo/Ed Andrieski
One was in early 2004, when then-chair Alan Greenspan mused in a speech that he didn't understand why more people weren't borrowing at low adjustable rates instead of higher fixed rates. Those who took his advice soon found themselves paying higher rates as the Fed began tightening money four months later, sending adjustable rates higher.
Going further back, to August 1990, I paid Mr. Greenspan a visit on the first of that month to warn him that a recession was nigh and that it might be a good idea for him to ease money. He did not heed this advice until several months later "” too late to avert a recession (which, incidentally, began in August).
Then, of course, there was the major mistake the Fed made between 1929 and 1933, when it allowed the money supply to shrink by one-third. The lack of liquidity in the economy caused widespread deflation, thus helping to turn the ongoing recession into what became known as the Great Depression.
Mistakes aside, Fed forecasts could also wind up wide off the mark because the central bank has to change course due to unforeseen developments.
To avoid the wrath of the markets and the Congress, the Fed might have to remind people of the seer's credo: "If you have to forecast, do it frequently."
Irwin Kellner is MarketWatch's chief economist.
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Irwin Kellner, MarketWatch's chief economist since 1998, writes a weekly column on the economy and the financial markets. He has been a leading economist for... Expand
Irwin Kellner, MarketWatch's chief economist since 1998, writes a weekly column on the economy and the financial markets. He has been a leading economist for more than 40 years and previously served as chief economist for North Fork Bank, Chase, Chemical and Manufacturers Hanover. Widely quoted by the media in the U.S. and abroad, Kellner regularly addresses groups of business people and community leaders and appears regularly on Cablevision's News 12 Long Island. Collapse
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