Bernanke Models Prove Faulty as Forecasts Succumb to Change
Chairman Ben S. Bernanke and his Federal Reserve colleagues are preparing to meet next week as two-year Treasury yields near a record low signal a U.S. economy on the knife’s edge between growth and contraction.
Guiding their assessment of the outlook for the world’s largest economy will be forecasts contained in the so-called Teal Book, a confidential staff report with a blue-green cover. Policy makers’ confidence in those forecasts may be tempered as the course of the expansion has confounded their expectations.
Of 12 Fed staff forecasts since the beginning of 2010, seven have been downward revisions to the near-term outlook, according to minutes of Federal Open Market Committee meetings. This year, the outlook was raised in January and lowered three times since as a stream of data on weakness in employment and consumer spending signaled threats to a recovery from the deepest recession since the Great Depression.
“We haven’t had any historical event that really would allow us to reliably statistically calibrate an event like the one we’ve had,” David Stockton, director of the Fed’s Division of Research and Statistics, who has overseen forecasting for a decade, said in an interview at the end of June. “There isn’t going to be a simple story here.”
Uncertainty can cause central bankers to keep their hands off the levers of monetary policy and wait for more information, said Antulio Bomfim, senior managing director at Macroeconomic Advisers LLC in Washington. When risks to growth stack up, as is the case now, Fed officials have to be mindful of more severe scenarios rather than just their baseline outlook, he said.
“When you are less confident about the forecast, you become more sensitive to the incoming data,” Bomfim said. With the economy growing at a 1.3 percent annual rate in the second quarter and 0.4 percent in the first three months, Fed policy makers are now “tilting toward easing,” said Bomfim, who worked at the Fed Board’s divisions of Monetary Affairs and Research and Statistics from 1992 to 2003. “We don’t think they will announce an easing action next week, but we think easing is back on the table.”
The FOMC meets for one day on Aug. 9. At their last meeting in June, Fed officials decided to keep the central bank’s balance sheet at a record to spur the slowing economy after completing $600 billion of bond purchases.
‘All the Options’
In testimony to Congress last month, Bernanke signaled the central bank has more tools for easing should the economy weaken. “We have to keep all the options on the table,” he said.
That testimony was followed by reports on industrial production, consumer spending and employment that were weaker than predicted by economists. The data have also called into question the forecast of Fed governors for a pickup in growth in the second half of 2011. Central bankers estimated in June the economy would grow 2.7 percent to 2.9 percent this year and that the unemployment rate would move down to 8.6 to 8.9 percent in the fourth quarter.
Employers added 117,000 workers to payrolls in July, more than forecast by economists, and the unemployment rate unexpectedly fell to 9.1 percent from 9.2 percent in June, a Labor Department report showed today.
Treasuries dropped after the report, pushing yields higher. The yield on the two-year note rose to 0.29 percent at 8:49 a.m. in New York after falling to a record-low 0.25 percent yesterday.
The high jobless rate hasn’t helped Bernanke’s standing with the public. A Bloomberg National Poll conducted June 17-20 showed Bernanke was viewed favorably by 30 percent of those polled, compared with 26 percent who view him unfavorably; the remainder were unsure. In September of 2009, Bernanke enjoyed 41 percent approval and 22 percent disapproval.
Fed staff forecasters have been thrown off by unforeseen shocks that have rammed the economy, such as the threat of a European default in April 2010 and higher oil prices this April. Alongside such one-time events are more lasting changes in the way U.S. consumers and companies behave that Fed officials are still trying to comprehend.
Every six weeks, Stockton and a team of 50 economists prepare a forecast that on average looks out eight quarters, while also giving policy makers a “now-cast” about how the economy is progressing today. They also generate as many as seven alternative scenarios that describe how the economy might underperform or outperform the baseline outlook.
Few people outside of the Fed know Stockton, who has headed the research division since July 2000. He doesn’t give speeches or write a blog. His name isn’t a buzzword like “Reinhart and Rogoff,” a frequently used reference to Carmen Reinhart, an economist at the Peterson Institute for International Economics in Washington, and Harvard University professor Kenneth Rogoff, the authors of a book on financial crises titled “This Time is Different.”
Yet former Fed Chairman Alan Greenspan, in his memoir “The Age of Turbulence,” called Stockton “the indispensable, behind-the-scenes staffer.”
On Oct. 1, Stockton, 57, will retire from the Fed after 30 years. He will be succeeded by David Wilcox, 52, a Massachusetts Institute of Technology Ph.D. who has worked at the Fed Board since 2001. He was an assistant secretary for economic policy at the Treasury from 1997-2001, and an economist at the White House Council of Economic Advisers from 1994-1995. Wilcox will lead the Teal Book discussion at the Aug. 9 meeting.
Stockton calls the 2007-2009 period “an unprecedented financial crisis in the lives of almost every economic agent.”
“That had profound effects on people’s balance sheets, on their spending, and their impetus to deleverage,” he said in the interview. “Something beyond transitory factors are at work.”
Suite of Models
The suite of models used by Fed staff to forecast changes in consumption and investment rely to some extent on past relationships between interest rates, income, and profits. Most also assume credit will be supplied and demanded at a given price or interest rate. Without adjustments, they revert to the mean -- after a period of slump they begin to point upward, in line with previous recoveries.
All of those tendencies have made the models less trusty guideposts for what is happening in the current recovery. The staff has to venture judgments and explore new analyses.
“Something new and different is going on,” said Allen Sinai, chief global economist at Decision Economics Inc. in New York. “Neither monetary nor fiscal policy is giving us the kind of bang we have traditionally got. The household sector is simply not spending as it has in the past.”
Nowhere have historical patterns gone more off the rails than in labor markets. Forty-four percent of the unemployed workers in the U.S. now have been without a job for 27 weeks or more, near the 45.6 percent peak in May 2010, the highest of any business cycle in the postwar period.
The persistence of high unemployment, a concern Bernanke has voiced on several occasions, ripples through the economy. A high jobless rate reinforces low income expectations and can result in an enduring trend of pessimism that makes consumer spending difficult to predict.
One of the indicators Fed staff are watching is the Thomson Reuters/University of Michigan survey of income expectations. The majority of consumers surveyed in June expected no income increase in the year ahead, as they have in every survey for the past 30 months. That’s a record, according to Richard Curtin, director of the survey.
Fed staff are also reviewing production schedules and contacting auto companies to gauge how the resolution of supply chain disruptions following the Japanese earthquake and tsunami in March may lead to higher production of cars and trucks.
That could provide a boost to GDP in the second half. Yet without follow-on purchases, the cycle of investment spending and hiring won’t engage. Consumer spending, which decelerated to a 0.1 annual rate in the second quarter from 2.1 percent the previous three months, signals trouble on that front.
Ordinarily, monetary policy works by making borrowing cheaper so households and businesses can access credit and keep their consumption stable through an economic slump. Now, that channel is less effective.
Banks have raised lending standards, and the private sector’s expectations about consumption may be shifting to a lower path, said Julia Coronado, chief economist for North America for BNP Paribas in New York, who worked for Stockton from 1997 to 2005.
“This is a standard-of-living shock,” Coronado said. “What we thought we could afford, and what we leveraged to, is much more than we can afford at present and in the future.”
To contact the reporter on this story: Craig Torres in Washington at firstname.lastname@example.org;