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February 3, 2015

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Posted: 03 Feb 2015 12:06 AM PST

'Persistent Overoptimism about Economic Growth'

Posted: 02 Feb 2015 11:49 AM PST

An SF Fed Economic Letter from Kevin Lansing and Benjamin Pyle:

Persistent Overoptimism about Economic Growth: In November 2007, the Federal Open Market Committee began releasing projections for real GDP growth four times per year in its Summary of Economic Projections (SEP). The SEP reports the central tendency and range for real GDP growth forecasts from the Federal Reserve Board members and Federal Reserve Bank presidents. Over the past seven years, many growth forecasts, including the SEP's central tendency midpoint, have been too optimistic. In particular, the SEP midpoint forecast (1) did not anticipate the Great Recession that started in December 2007, (2) underestimated the severity of the downturn once it began, and (3) consistently overpredicted the speed of the recovery that started in June 2009. The SEP growth forecasts have typically started high, but then are revised down over time as the incoming data continue to disappoint. Similar patterns are observed in the consensus private-sector growth forecasts compiled by the Blue Chip Economic Survey. This Economic Letter reviews the SEP's track record of forecasting growth and considers some explanations for the optimistic bias. ...

Fed Watch: Fed's Preferred Inflation Measure Dives

Posted: 02 Feb 2015 10:37 AM PST

Tim Duy:

Fed's Preferred Inflation Measure Dives, by Tim Duy: Not only is core-PCE inflation on a year-over-year basis trending away from the Fed's target:

PCEa020215

but the deceleration in recent months is truly shocking:

PCEb020215

It is hard to see how the Fed can be confident that inflation with trend back to target when looking at these numbers. They need some acceleration in wage growth to justify their intentions to begin normalizing policy, and even with such acceleration, I think their case is fairly weak in the context of the current inflation environment. If they make a case, they will base it on these three pillars:

1.) With unemployment nearing 5%, they have reached their employment mandate.
2.) Monetary policy is exceptionally accommodative even if they raise interest rates.
3.) Failure to raise rates invites asset bubbles.

On point three, refer to New York Federal Reserve President William Dudley:

Quickly, let me give two examples that illustrate how variable this linkage can be.  First, during the 2004-07 period, the FOMC tightened monetary policy nearly continuously, raising the federal funds rate from 1 percent to 5.25 percent in 17 steps.  However, during this period, 10-year Treasury note yields did not rise much, credit spreads generally narrowed and U.S. equity price indices moved higher.  Moreover, the availability of mortgage credit eased, rather than tightened.  As a result, financial market conditions did not tighten.  

As a result, financial conditions remained quite loose, despite the large increase in the federal funds rate.  With the benefit of hindsight, it seems that either monetary policy should have been tightened more aggressively or macroprudential measures should have been implemented in order to tighten credit conditions in the overheated housing sector.

It may be that the Fed looks at the tech and housing bubble episodes and concludes that zero interest rates are not desirable even if inflation is below trend. Yes, I know, macroprudential before interest rates when addressing asset bubbles. But at a point when the economy is at the Fed's idea of full-employment, and given the events of recent decades? Easy to see the Fed seeing danger in putting all of their eggs in the macroprudential basket. 

Bottom Line: Below trend inflation as the economy nears full-employment is a very uncomfortable position for the Federal Reserve. It will be interesting to see how Federal Reserve Chair Janet Yellen navigates these waters at the upcoming Congressional testimony.

Paul Krugman: The Long-Run Cop-Out

Posted: 02 Feb 2015 08:48 AM PST

Focusing on the long-run and avoiding the harder, more important short-run questions is "craven and irresponsible"

The Long-Run Cop-Out, by Paul Krugman, Commentary, NY Times: On Monday, President Obama will call for a significant increase in spending, reversing the harsh cuts of the past few years. He won't get all he's asking for, but it's a move in the right direction. And it also marks a welcome shift in the discourse. ... It's often said that the problem with policy makers is that they're too focused on the next election, that they look for short-term fixes while ignoring the long run. But the story of economic policy and discourse these past five years has been exactly the opposite.
Think about it: Faced with mass unemployment and the enormous waste it entails, for years the Beltway elite devoted almost all their energy not to promoting recovery, but to Bowles-Simpsonism — to devising "grand bargains" that would address the supposedly urgent problem of how we'll pay for Social Security and Medicare a couple of decades from now.
And this bizarre long-termism isn't just an American phenomenon. ...
Am I saying that the long run doesn't matter? Of course not, although some forms of long-termism don't make sense even on their own terms. Think about the notion that "entitlement reform" is an urgent priority..., why, exactly, is it crucial that we deal with the threat of future benefits cuts by locking in plans to cut future benefits?...
All too often, or so it seems to me, people who insist that questions of austerity and stimulus are unimportant are actually trying to avoid hard thinking about the nature of the economic disaster that has overtaken so much of the world.
And they're also trying to avoid taking a stand that will expose them to attack. Discussions of short-run fiscal and monetary policy are politically charged. ... I understand why it's tempting to dismiss the whole debate and declare that the really important issues involve the long run. But while people who say that kind of thing like to pose as brave and responsible, they're actually ducking the hard stuff — which is to say, being craven and irresponsible. ...
So it's important to understand who's really irresponsible here. In today's economic and political environment, long-termism is a cop-out, a dodge, a way to avoid sticking your neck out. And it's refreshing to see signs that Mr. Obama is willing to break with the long-termers and focus on the here and now.

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