Pay No Attention To The Man Behind The Curtain (PNATTMBTC)

The most useful advice I have ever heard about predicting Federal Reserve (Fed) policy came from Larry Summers, currently at Harvard, who has held nearly every senior government role imaginable with the exception of Surgeon General. The advice was offered during an informal talk a couple of Fed chairs ago, so Professor Summers cannot be held accountable for my rendition today. The gist was that, because the Fed consistently tries to foster its mandate, one should pay more attention to forecasting the economic outlook and its implications for policy than listening to how officials describe that future action.

Three reasons come to mind why the words of a high (or even the highest) Fed official might not trace an accurate map of future policy.

First, even though the institution devotes enormous resources to forecasting, it is sometimes slow on the uptake to changed circumstances, producing forecast errors in the economic outlook that set the path of the appropriate fed funds rate off track. The Fed’s loyalty to the Phillips curve, for instance, led it to see disinflation in 2003 and 2004 and inflation lurking around the corner since 2016. Part of the story might be that it habitually undervalues the rest of the world’s role in shaping US economic performance.