In the past, the US Federal Reserve operated under a cloak of secrecy. Today, the deliberations and forecasts of the members are available to the public in a timely fashion.
Yet, this new visibility may well be generating an unintended side effect: the public, which used to believe in the omniscience of “Maestro” Alan Greenspan and his brethren, is learning how imperfect the stewards of monetary policy really are. This was always apparent to insiders. When I worked as an economist at Fed in Washington, DC in the 1990s, one of my responsibilities was to help produce the staff’s forecast for the economy. That outlook was a key input for the Greenbook—the document that Federal Open Market Committee (FOMC) members hold on their laps while they debate the course of monetary policy.
Throughout the year, the staff members would trade off responsibility for delivering the latest view on the state of the economy to the board members. That’s because the meetings could often be contentious. If the staff saw inflation accelerating and board members disagreed, then the poor staff member delivering the bad news would be barbecued.
While I was there, many of the governors weren’t trained economists and often seemed distrustful of the staff, treating our outlook with derision and promulgating their own views. Those views revealed at times a startling ignorance in the board member, but nonetheless influenced policy.
Such a dynamic is doubtlessly replayed on Wall Street every day, where traders without economic training have strong intuitive opinions that can move them to ignore the views of the firm’s economists.
Were the governors who disdained the work of the staff correct to do so? A fascinating new paper by economists Christina Romer and David Romer at the University of California at Berkeley suggests that on the contrary, the board members’ forecasts were worthless.
The authors conclude: “Someone wishing to predict actual inflation and unemployment, 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.”
That’s a troubling finding. The key individuals making crucial monetary policy calls had views about the economy that were often of no value. What is worse, the Romers find in their research that the incorrect views tended to influence monetary policy because FOMC members with “intuitive” or anecdotally-based views moved interest rates in response to their unscientific musings. On the other hand, it is reassuring to learn how competent staff members are. They are significantly more skilled at seeing the state of the economy than are private forecasters, and better than the FOMC members themselves, according to the Romers’ research.
The irony is that the increase in transparency, which has recently been adopted, makes the views of the FOMC participants more visible. In the past, their forecasts were made public twice a year; now it will be four times a year. The staff predictions will be kept from the public for five years.
That suggests a significant policy change is in order. The staff’s forecast is the best available view of the future path of the economy, yet it is hidden from the public. It shouldn’t be.
Why is the forecast not available yet? One concern is that it is so successful precisely because it is private. If we make it public, perhaps it would stop being so accurate.
Suppose, for example, Congress debates a stimulus package to fend off a recession, but economic science suggests that the package would have no real effect on the economy. The staff would have to build that disappointment into its forecast, along with a statement that regardless of the legislation, the outlook is bleak.
Opponents of the Congressional action would seize upon the Fed analysis, and proponents would seek to discredit it. This might expose it to political pressure. Wary of the turmoil, the staff might hedge on the value of the stimulus package. If it did, the forecast would have less value.
Such a dynamic might certainly exist, but the benefits of transparency must outweigh the costs. In my experience, staff outlooks are based on extremely rigorous scientific models, and not subject to extensive judgement. If the models are made public, then it is hard to quarrel with a forecaster relying on them, unless one wants to advocate an alternative model, and provide scientific proof that it is superior.
In the end, such a process could only help the Fed staff be even better.
And here is an easy way to get the ball rolling. One of the FOMC members should announce that his views are heavily influenced by the staff forecast. When that member releases his forecast, everyone will know that it is really the staff forecast they are looking at. Since the connection will be implicit, it should protect the staff from the negative consequences of public revelation. FOMC members can no longer rely on their perceived infallibility when making pronouncements about the economy. But they can rely on the best available economic science, and the sooner the better.
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Kevin Hassett, director of economic policy studies at the American Enterprise Institute, is a Bloomberg columnist. He is an adviser to Republican senator John McCain of Arizona in his bid for the 2008 presidential nomination. The opinions expressed are his own.