Let's Give the FOMC Pessimists a Listen

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On Wednesday Fed Chairman Bernanke presented the updated economic forecasts of members of the policymaking Federal Open Market Committee (FOMC) as part of the Fed's semi-annual Monetary Report to the Congress.

The forecasts were not greatly different from the FOMC projections released last October and on average anticipate moderate economic growth in 2010 - 2012, slowly declining unemployment, and continued low inflation. The forecasts take into account the monetary policy that each FOMC member considers most appropriate.

The forecasts of the Federal Reserve Bank presidents and the members of the Federal Reserve Board who make up the FOMC are reported in a range that gives the highest and lowest projection values for each variable. Central tendency projections that exclude the three highest and the three lowest values are also presented and, indeed, featured. Analysts and the media typically focus on the narrower central tendency data.

But in the present period of early economic recovery following a devastating recession, economic forecasts are necessarily subject to considerable uncertainty, so it's illuminating to examine the extreme values of individual FOMC members' forecasts.

Not surprisingly, the committee's mid-2007 forecasts for the fourth quarter of 2008 were way off base, since a recession wasn't anticipated. Hence the smallest forecast errors from the full range of FOMC members' estimates were for the most pessimistic projections.

What about the forecasting errors for the depressed years 2008 and 2009 based on FOMC projections released in late February 2008 when the economy was in retreat from full employment? (The FOMC forecast values for economic growth and inflation are the percent change for the fourth quarter of the year shown over the fourth quarter of the previous year, and the forecast value for the unemployment rate is for the fourth quarter of the year designated.)

For economic growth, the FOMC predicted a range of 1.0 percent to 2.2 percent for 2008, and 1.8 percent to 3.2 percent for 2009. The actual growth rate for 2008 was negative and for 2009 it was near zero. Thus, the most pessimistic individual forecasts from the full range projections were closest to the actual outcome in both years and were closer to the mark than the central tendency forecasts.

The committee's unemployment rate forecasts made early in the recession varied between 5.0 percent and 5.5 percent for 2008 and between 4.9 percent and 5.7 percent for 2009. The actual values turned out to be 6.9 percent and 10.0 percent respectively. Again, the most pessimistic values from the full range projections in both years were the least inaccurate, with the more publicized central tendency forecast values for economic growth and unemployment faring even worse.

For core personal consumption expenditure inflation (which excludes food and energy prices), the FOMC projected a 1.9 percent to 2.3 percent range for 2008, and 1.7 to 2.2 percent for 2009. In this case the forecasts were on the mark or close to it - the actual values were 2.1 percent and 1.3 percent respectively and not much different from the central tendency projections.

These limited comparisons suggest that FOMC forecasts - the most pessimistic in the above examples - can at times in the business cycle be more accurate if extreme values are not excluded.

We don't know whether the latest forecasts of the FOMC bulls or bears will come closer to the mark in the years ahead. If the pessimists do better again, we can expect only a mild economic recovery. The FOMC low-end projections anticipate economic growth rates of 2.3, 2.7, and 3.0 percent for 2010, 2011, and 2012 respectively. For unemployment, the FOMC bears anticipate mildly falling jobless rates of 10.0 percent, 8.8 percent, and 7.6 percent for this and the next two years - not a rosy outlook.

If the optimists prevail, economic growth will gradually pick up steam, from 4.0 percent this year to 4.7 percent next year and to 5.0 percent in 2012. The unemployment rate will fall from 8.6 percent later this year to 7.2 percent in 2011 and to 6.1 percent in 2012.

For core inflation, both the FOMC optimists and pessimists are predicting that price increases will be contained. For the three years 2010 - 2012, the high forecasts are 2.0, 2.4, and 2.0 percent and the low forecasts are 1.0, 0.9, and 0.8 percent.

If there is a lesson to be learned, it's that perhaps we shouldn't be too hasty throwing out the carefully prepared outlying projections of Fed governors and bank presidents that may contain valuable information.

Alfred Tella is a former Georgetown University research professor of economics. 

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