MUNCIE, Ind. – Federal Reserve Bank of St. Louis President James Bullard reflected on Federal Open Market Committee (FOMC) forecasts running up to 2015 and their implications for monetary policy. He delivered his remarks during the 20th Annual Indiana Economic Outlook Luncheon at Ball State University on Monday.
During his presentation, titled “A Hat Trick for the FOMC,” Bullard noted that each quarter, FOMC participants prepare forecasts for variables including real gross domestic product (GDP) growth, the unemployment rate and inflation. In the last 18 months, the FOMC has been surprised on all three of those variables, he said. “The surprise has been that real GDP growth has been slower than expected, inflation has been lower than expected, and labor markets have improved more rapidly than expected,” he explained.
“These misses are such that they continue to pull the Committee in different directions on monetary policy,” Bullard said. “Unexpectedly low inflation and real GDP growth suggest pushing policy in a somewhat easier direction. Robust labor markets suggest pushing policy in a somewhat tighter direction,” he explained. Bullard noted that, in response to these surprises, the FOMC’s adjustment to policy was to move toward a later normalization.
Assessment of FOMC Forecasts for 2015
Since FOMC participants’ forecasts are submitted under an assumption of appropriate monetary policy, “this aspect of the exercise clouds the meaning of these Committee forecasts,” Bullard said, adding, “This is a long-standing problem.” However, during his presentation, he treated the FOMC prognostications as forecasts of what will actually happen.
Bullard examined the FOMC’s 2015 forecast ranges and “central tendency”—which omits the three highest and three lowest projections—for three macroeconomic variables. The forecasts he assessed for 2015 were those made for the June 2014 FOMC meeting.
Regarding the FOMC’s GDP forecasts, Bullard noted that the central tendency of the FOMC overestimated real GDP growth for 2015. The bottom line, he said, is that the growth forecast was too high for 2015. This includes the St. Louis Fed’s own forecast, he added.
Bullard then turned to a discussion of the FOMC forecasts for unemployment. “The Committee missed the extent of the decline in unemployment in 2015, expecting less labor market improvement than was observed,” he said. While the St. Louis Fed had one of the lower forecasts for the end-of-year unemployment rate for 2015, he noted that this estimate was still too high. Thus, for the third year in a row, Bullard said that the FOMC was too pessimistic on labor market improvement.
Bullard added that forecasts from the private sector have also been too pessimistic on unemployment. “Fed and private sector forecasters may want to change their thinking on unemployment, having been wrong three years in a row,” he said.
In discussing inflation forecasts, Bullard noted that the FOMC, as well as the St. Louis Fed, overestimated headline inflation for 2015. “However, a large oil price shock is still influencing the inflation numbers,” he said. Bullard added that while the FOMC was closer on its forecast for core inflation (which excludes food and energy prices), it was also still too high, as was the St. Louis Fed’s core inflation forecast. “We expected inflation to rebound as the economy improved,” he noted.
Implications for Current Monetary Policy
In traditional central banking, Bullard explained that when macroeconomic performance deviates from expectations, policymakers chart a different course for interest rates. “The surprisingly strong improvement in labor markets suggests somewhat earlier and faster policy rate increases than would otherwise be the case. But the slower-than-expected real GDP growth and lower-than-expected inflation suggest somewhat later and slower policy rate increases than otherwise,” he said.
The result, he noted, was a more dovish policy stance. “The Committee did adjust the policy rate path in response to the news embodied in forecast errors between the summer of 2014 and today,” Bullard said, adding that this adjustment was toward a later increase in the policy rate from near zero.
“This can be interpreted as showing that the Committee does react to news on the economy that deviates from expectations,” Bullard said. “It also suggests that negative surprises with respect to real GDP growth and inflation carried more weight during this period than the positive surprises on labor market performance.”