Anyone who has worked in a large organization knows the syndrome: top executives are briefed by their subordinates and go and make pronouncements even though they are stretched too thin to have a full understanding. A study by two University of California (Berkeley) economists concludes that that pattern applies to the Fed.
Christina and David Romer don’t merely find that forecasts by senior Fed members, such as the minutes of FOMC are “useless”; they think they have the potential to be counterproductive.
Federal Reserve policy makers’ economic projections are useless and possibly misleading when given greater weight than more accurate forecasts by central bank staff, according to two scholars.
“Policy makers certainly talk as if they believe they have useful information to add to the staff’s forecasts,” University of California, Berkeley, economists Christina and David Romer wrote in a paper to be presented at a conference Jan. 4. “For the most part, they do not.”
The Romers are on the seven-member business-cycle dating committee of the National Bureau of Economic Research, the Cambridge, Massachusetts, group that charts U.S. expansions and recessions. The couple’s paper calls into question the usefulness of the Fed’s November decision to boost disclosure of central bankers’ views on inflation, unemployment and growth to four times a year.
The study also raises concern about the relationship between Federal Open Market Committee members’ views and the staff outlook, which may be in conflict.
“FOMC members fail to add information,” the Romers wrote. “Their efforts to do so are actively counterproductive.”
The Romers have published several research papers on the history of Fed decision making. Their most recent work is entitled “The FOMC versus the Staff: Where Can Monetary Policy Makers Add Value?” and will be presented at the American Economic Association’s annual meeting in New Orleans.
The Romers concluded that the FOMC’s inflation forecast “does not contribute useful information,” and “someone trying to forecast actual inflation should move away from the FOMC forecast not toward it.”
Their study of unemployment forecasts found similar results. The data was “slightly supportive” of the FOMC’s economic growth outlook versus the staff, the Romers wrote.
“Considering members’ forecasts is not just a waste of effort on the part of the FOMC, but may lead to misguided actions,” the Romers wrote.
Fed Vice Chairman Donald Kohn and former Monetary Affairs Director Vincent Reinhart will discuss the Romers’ paper at the conference…
“It is the longer-run part of the forecast that matters, and the Romers don’t assess that,” said Reinhart, who is now a resident scholar at the American Enterprise Institute in Washington. FOMC members “can be bad forecasters and good policy makers if the diversity of views about the outlook informs their policy choice,” he added…
Fed staff provides a new forecast on the economy every six weeks. Fed officials, including reserve bank presidents and governors, rely on their own forecasting staff and information from local business contacts.
“Someone wishing to predict actual inflation and employment who had access to the forecasts of both the FOMC and the staff would be well served by throwing away the FOMC forecast and just using the staff predictions,” the Romers said