The Public Policy

Pessimism Revised

Latest Federal Reserve predictions suggest a bleaker next two years than anticipated.

By 12.6.10

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On November 23, the Federal Reserve's Open Market Committee released the minutes from its November 2-3 meeting.

Before getting into the important data regarding the FOMC members' updated forecasts for future economic activity, it should be pointed out that the FOMC staff also have an economic forecast. While the specifics of the staff forecast are not in the minutes, they do mention that "the staff revised up its forecast for economic activity in 2011 and 2012." But note the caveats to this optimism: "the November forecast was conditioned on lower long-term interest rates, higher stock prices, and a lower foreign exchange value of the dollar than was the staff's previous forecast."

Perhaps just to tell the FOMC staff what the markets think of their assumptions, Tuesday gave us much lower stock prices and a much higher foreign exchange value of the dollar, with the USD settling at a 2-month high versus the Euro, with that currency-in-turmoil worth less than $1.34.

Turning to the people whose votes count, the Federal Reserve Board Governors gave new projections on GDP growth, unemployment, and inflation, with their last predictions having been made for the June FOMC meeting.

The results are dramatic in the normally boring world of the Fed: All of the participants' projections for GDP growth for 2010 (which we obviously have almost all the data for already) were between 2.3% and 2.5%, whereas in June, the predictions ranged from 2.9% to 3.8%.

Looking to the future rather than the past, the "central tendency" of GDP projections for 2011 (which removes the three lowest and three highest predictions) fell from a range of 3.5%-4.2% to a range of 3.0%-3.6%, a drop of about ½% of GDP. With GDP around $15 trillion, we're talking about $75 billion less in economic activity, or about $250 for every man, woman, and child in the United States. This is a huge change for just one year from now. Furthermore, since GDP growth is then compounded, this basically means we'll be much poorer every year for the foreseeable future than FOMC participants had expected.

Though the central tendency for 2012 was little changed, the range of guesses fell from 2.8%-5.0% to 2.6%-4.7%.

More importantly, in terms of politics, was the stunning jump in FOMC members' predictions of future unemployment: Again, we know this year's data, so the key aspect of the new 9.5%-9.7% range is that it shows the FOMC having been too optimistic in the past, with the June prediction being 9.2%-9.5%.

But the real story is in the updated forecasts for 2011 and 2012. The new central tendency for 2011 is 8.9%-9.1% versus a June prediction of 8.3% to 8.7%. Using the midpoint of the ranges, the new forecast is a full ½% higher than just 5 months earlier. The 2012 numbers are even worse, with a new range of 7.7% to 8.2%, up from 7.1% to 7.5%, an increase of 0.65% from midpoint to midpoint.

The first factor listed in the minutes as to why participants thought growth would be slower than previously expected was "a high degree of caution exhibited by consumers and businesses." And why wouldn't we be cautious with a government that has gone from wanting to control or destroy private industries from cars to health insurance to banking, to looking utterly incompetent, confused, and ineffective in everything from tax policy to negotiating free trade agreements? There's no way to know what the next shoe will be to drop and therefore little incentive to take entrepreneurial risk.

The minutes also show disagreement about the value and risks of "QE2," the Fed's aggressive Treasury Security purchasing program. Some members thought that the program would help the economy by keeping long-term interest rates low and perhaps by preventing disinflation or deflation. "Some participants, however, anticipated that additional purchases of longer-term securities would have only a limited effect on the pace of the recovery; they judged that the economy's slow growth largely reflected the effects of factors that were not likely to respond to additional monetary policy stimulus…" They also noted risks of debasing the value of the dollar and causing "an undesirably large increase in inflation."

In other words, the Federal Reserve, which is supposed to be a stabilizing buffer against the chaos of the fiscal policies of the elected branches of government, is in the view of even some of its own Governors potentially adding to rather than dampening our current economic turmoil.

The FOMC's new projections, if accurate, could spell disaster for Democrats in 2012. As James Carville famously quipped, "it's the economy, stupid." Indeed it is.

While the Fed's new forecasts might gladden the heart of someone who would love to see Barack Obama be a one-term president, we must not forget the huge cost to our nation of millions of people kept unemployed by the ultra-Keynesian policies being implemented by the current administration and Obama's willing accomplice, "Helicopter Ben" Bernanke. These policies are all the more reprehensible because Bernanke is an economic historian and the lessons of history are replete with the consistent and utter failure of Keynesian economics.

To the extent that Democrats in Congress believe, as President Obama and Nancy Pelosi have both suggested, that their 2010 electoral drubbing was due to simply not explaining their actions well enough, their echo chamber will cause them to ignore the screaming, pleading voices of an American citizenry desperate for economic stability. We should all hope that the Fed's new projections are overly pessimistic; but should they be accurate (or not pessimistic enough) we should all endeavor to ensure that those responsible for economic failure pay a political price when the votes are counted two years from now.

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About the Author
Ross Kaminsky is a self-employed trader and investor and is a senior fellow of the Heartland Institute. He is the host of The Ross Kaminsky Show on Denver's NewsRadio 850 KOA on Saturday mornings from 6 AM to 9 AM. You can reach Ross by e-mail at rossputin(at)rossputin(dot)com.