Citi: The Fed May Have Kept Policy too Loose Because of Faulty Data

End-of-summer job growth is stronger than you think.

The Fed: a hotbed of short-termism?

Photographer: Andrew Harrer/Bloomberg

Remember residual seasonality?

In mid-May, Wall Street economists, along with researchers at select regional Federal Reserve banks, convincingly argued that first-quarter gross domestic product figures were skewed to the downside because of some statistical discrepancies.

Since the end of the Great Recession, growth has actually been smoother than we thought, they contended.

Now, economists at Citigroup, led by Peter D'Antonio, have invoked the term once again to describe the tendency for the initially reported monthly job numbers in the late summer months to be soft.

Looking at the data, one could get the impression that the improving U.S. labor market was beginning to falter near the end of the third quarter over the past few years. Subsequent adjustments would show that employment growth hadn't lost much momentum; readings in August and September have typically been revised higher.

This, D'Antonio says, is a problem, considering how many times over the past four years the Fed has made important decisions in the wake of potentially flawed figures at that time of the year.

"The history of payroll revisions for August and September has shown that some of those decisions might have been based on false signals, which could have biased policy toward accommodation," he wrote.

Consider some recent instances:

  • 2011: The Fed's "Operation Twist" is launched after the August non-farm payrolls report shows the economy failed to add any jobs over the course of the month.
  • 2012: The U.S. central bank unveils a third round of quantitative easing after employment growth in August failed to crack 100,000, falling shy of economists' expectations.
  • 2013: The dreaded "Septaper" fails to occur, with the Fed electing not to declare the beginning of the end for its bond-purchasing program until December.
  • 2015: The central bank once again opts to keep interest rates near zero, delaying liftoff.

To the extent that recent labor market figures had played a role in monetary policymakers' choices, the central bank kept policy too accommodative in 2011 and 2013, argues D'Antonio:

In each case, subsequent data showed that the August jobs data had been misleadingly weak – the labor market had been improving all along. We believe that in two of the cases, FOMC members might have made different decisions had they had full information. In 2011, the rationale for Operation Twist had disappeared by the time the policy was put into effect. In 2013, the Fed reversed its taper delay and announced the start of tapering three months later.

The economist admits that international and financial market developments, rather than anything U.S.-centric was, however, what prompted the central bank to stay on hold this season.

Janet Yellen said as much during the press conference following the Fed's latest decision when she suggested that the domestic economy, in isolation, was indeed ready for a rate hike.

"However, the softer-than-expected August payroll figure provided additional cover for the FOMC to want more evidence of 'some further improvement in the labor market,'" added D'Antonio.

Citi's analysis assumes that a recency bias has perennially pervaded the Fed and may play a bigger role than the corpus of economic trends at a given moment.

On the other hand, one could argue that the hatchet taken to the central bank's June economic forecasts in the wake of disappointing first-quarter prints over the past few years could be viewed as a sign that the central bank was, in general, placing too much emphasis on recent growth numbers.

So it's not unreasonable to suggest that these Citigroup economists stumbled upon a quirk in the data that has unduly influenced the Fed's outlook and has possibly affected the monetary policy sausage-making process.

But if the Federal Reserve has indeed been keeping policy too stimulative over the past four years, it seems someone forgot to give inflation—still stuck in the ultra-low doldrums—that memo.

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