INDIANAPOLIS – Federal Reserve Bank of St. Louis President James Bullard discussed “Ghosts of Forecasts Past and Future” at an economic outlook forum hosted by the Indiana Bankers Association on Friday.
During his presentation, Bullard reviewed Fed forecasts of real GDP growth, the unemployment rate and inflation over the past several years and for 2014. The forecasts are made by Federal Open Market Committee (FOMC) participants each quarter.
Bullard cautioned that FOMC forecasts are made under the “appropriate monetary policy” assumption of each FOMC participant. “Nevertheless, interpreted as straight forecasts of what will happen, the FOMC was about right on real GDP growth in 2013, too pessimistic on unemployment and surprised by low inflation,” he said. Bullard noted that the St. Louis Fed’s 2013 forecast had the same character but was more accurate on the unemployment dimension.
For 2014, Bullard said the St. Louis Fed continues to project improved growth prospects for the U.S. economy and expects real GDP growth to exceed 3 percent. In addition, the St. Louis Fed continues to expect unemployment to fall, reaching 6.2 percent on average during the fourth quarter of this year. He also noted that, despite being surprised by low inflation during 2013, the St. Louis Fed continues to project higher inflation going forward, with both core and headline inflation reaching 1.6 percent by the fourth quarter of 2014.
The Policy Assumption
Since FOMC participants’ forecasts are submitted under an assumption of appropriate monetary policy, “this aspect of the exercise greatly clouds the meaning of these Committee forecasts,” Bullard said.
He discussed two possible interpretations of what an individual participant is saying with his or her forecasts. Is it that the forecast outcomes are possible but only under that participant’s policy assumption? Or is it that the forecast outcomes are likely given the path of policy forecast by that participant, even if he or she views a different policy as appropriate? “This is a long-standing problem with FOMC forecasts,” Bullard said.
When most outside observers look at FOMC forecasts, Bullard noted that they simply ignore the policy assumption and instead treat the prognostications as forecasts of what will actually happen. That is how he discussed the forecasts during his presentation. (For a technical discussion on this and related issues, see Bullard’s “Discussion of Ellison and Sargent: What Questions are Staff and FOMC Forecasts Supposed to Answer?” on March 30, 2009.)
Turning to the policy assumption, Bullard noted that current FOMC monetary policy consists of two parts—the ongoing asset purchase program and forward guidance. “This is a relatively complicated policy setting compared to normal times, and so it is hard to characterize current policy completely,” he said. Instead, a market expectation of rates could be used as the policy assumption.
Forecasts for 2013
Bullard turned to a discussion of FOMC forecasts over the past several years, focusing on those for 2013. The FOMC got the GDP growth forecast for 2013 about right, Bullard noted, adding that much of this success is because GDP growth estimates for the third and fourth quarters have been revised up considerably over the past several weeks. “The general theme that I championed early in 2013, that 2013 would be better than 2012, also appears to have been correct,” he said, adding that the failure to hit 3 percent growth was due mainly to the first quarter of 2013.
Regarding unemployment forecasts, Bullard noted that the FOMC was generally too pessimistic on unemployment during 2013. Actual fourth-quarter average unemployment for 2013 came in at the lower edge of FOMC point forecasts, which he noted was about at the St. Louis Fed’s forecast.
“The current unemployment rate is substantially below the expectations at the time of the September 2012 decision to begin the current open-ended asset purchase program,” Bullard said. “This is certainly one important aspect of the substantial labor market improvement the Committee was seeking in pursuing the program.” Indeed, the FOMC cited improved labor market conditions in its December 2013 decision to begin tapering.
In discussing inflation forecasts, Bullard said, “Inflation surprised to the downside in 2013.” While the St. Louis Fed projected that inflation would be at about 2 percent as of the end of 2013, Bullard noted that it is instead running closer to 1 percent. All of the FOMC point forecasts were too optimistic about inflation moving back toward the Committee’s target of 2 percent, he said, adding that there is no generally accepted explanation for the low inflation readings.
Forecasts for 2014
Turning to forecasts for this year, Bullard noted that the St. Louis Fed’s forecast for real GDP growth is 3.2 percent, which is on the high side of FOMC point forecasts. (Forecasts for 2014 were those prepared for the Dec. 18, 2013, Summary of Economic Projections.) “The empirical models we use continue to suggest that with today’s very low interest rates, more rapid economic growth is likely going forward,” he explained. “We think that many of the obstacles to faster growth have been dissipating.”
Similarly, the St. Louis Fed’s forecast for 2014 for the fourth-quarter average unemployment rate (6.2 percent) is the most optimistic of the forecasts on the FOMC, Bullard said. He explained that this forecast is based on several factors, including the Bank’s success in extrapolating the trend rate of decline over the past several years. In addition, “we expect more rapid growth, which should put additional downward pressure on unemployment.” Also, he said, “we think that today’s labor force participation rate is about right given observed demographic trends.”
On inflation, Bullard noted that the St. Louis Fed’s forecast for 2014 for both core and headline inflation is 1.6 percent, meaning that inflation will be higher in 2014 than it is currently and closer to the FOMC’s target of 2 percent. These forecasts are in the central tendency of the FOMC forecasts for this variable. “Because inflation surprised to the downside in 2013, it remains a wildcard for the Committee in 2014,” Bullard said.