The Federal Reserve’s track record of economic forecasting is a lot better than many observers recognize. It might also offer some insight into the central bank’s approach to managing the recovery.
Criticism of the Fed’s forecasting has focused largely on its failure to recognize, as late as mid-2008, the depth and persistence of the recession that the global financial crisis would engender. I agree that this error — which the Fed was not alone in making — should lead economists at the central bank and elsewhere to do a better job of including financial markets in their forecasting models.
That said, the Fed’s forecasters did better after the recession. Consider, for example, the projections they supplied for the central bank’s November 2010 policy-making meeting (the latest for which staff materials have been released to the public). Here’s how their estimates of unemployment and inflation, formulated in October 2010, compare to what actually happened:
The forecast accurately captured a slow but steady recovery in the unemployment rate (which was 9.5 percent in the fourth quarter of 2010), and core inflation (excluding food and energy) exceeding 1 percent but still falling short of the Fed’s 2 percent target for many years.
Granted, the forecasters made significant errors. They overestimated the fourth-quarter 2015 level of inflation-adjusted gross domestic product by 10 percent, and missed the end-2015 short-term interest-rate target by more than four percentage points. That said, the successes are much more striking: Given all the shocks the economy sustained over the period, how could the Fed’s forecasters have been so right?
My (tentative) answer: From 2011 through 2015, the Fed managed the economy with two complementary goals: Get the unemployment rate down to 5 percent (from near 10 percent) and keep inflation in a range between 1 percent and 2 percent. It adjusted monetary policy in response to shocks in order to achieve these complementary goals. In other words, the forecast for unemployment and inflation was accurate because the Fed made it so.
This raises another question: Could the Fed have achieved better growth and gotten interest rates back up to normal more quickly if it had aimed for a sharper decline in the unemployment rate and allowed inflation to run above target? It’s a subject that economists will study for years to come, and that could offer key lessons on how to handle the next recession.
Narayana Kocherlakota, a Bloomberg View columnist, is the Lionel W. McKenzie professor of economics at the University of Rochester