Fed Policy Under Graphs

I don’t want to spend a lot of time on the Fed.  I do want to shine a light on their lack of forecasting abilities.  You have to understand, they are cheerleaders for the US economy, and usually (though not now) defenders of fiscal policy.

The following figures are based off my weighted average estimates taken from the Fed’s guidance.

Let’s start with their forecasts of GDP growth.

Fed

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Yes, the unemployment rate has come down, but much of it it due to discouraged workers. Also, younger people are having a hard time finding work, while oldsters are having to work to survive.

Now let’s look at the hyper-optimistic PCE deflator:

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Inflation has been falling as the PCE measures it, and CPI also.  Asset inflation has taken the place of goods and services price inflation.  Eventually, that will switch, when the relative need to consume rises, as it did in the ’70s.

Now let’s look at the expectations for the Fed Funds rate:

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Fed funds continually moves down over time. The Fed overestimates when they will tighten, because the economy is far weaker than they expected (go back to graph 1). The final graph confirms this:

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Thus the futility of the Fed. After almost two years of giving guidance, they are no closer to tightening than when they started.  Tightening is 27 months away, if their estimates are right, same as they thought in January 2012.  Tightening seemed further away when more aggressive QE was introduced, but that quickly abated, like a drug addict adjusting to higher doses.

Lousy Forecasters

The Fed’s ability to forecast, since it began communicating more under Greenspan, has never been good.  They are always too optimistic, and assume the powers of monetary policy are high, when they are low.  This applies double to abnormal policy like QE.

Perhaps the Fed could do us a favor.  Stop the shenanigans, and let the yield curve get a normal slope between 2- and 10-year Treasuries, around 1%.  Also end QE.  Then tell Congress that the ball is in their court, and the Fed won’t do any more “stimulus.”  Then Congress would have to face their own shortcomings, and decide if they are Keynesians or Austrians, and act.  Congress dallies because the Fed acts.  Voters can punish Congress; they can’t punish the Fed, much as it deserves it.  If we need a recession to clear away bad debt, so that we can grow again, let’s have it, and stop the asset inflation that the Fed engenders.

As it is, I don’t think QE is doing much good at all for the US, unless monetizing the debt is something good, which historically leads to high inflation.

By David Merkel, CFA of alephblog.com



About the Author

David Merkel
David J. Merkel, CFA, FSA — 2010-present, I am working on setting up my own equity asset management shop, tentatively called Aleph Investments. It is possible that I might do a joint venture with someone else if we can do more together than separately. From 2008-2010, I was the Chief Economist and Director of Research of Finacorp Securities. I did a many things for Finacorp, mainly research and analysis on a wide variety of fixed income and equity securities, and trading strategies. Until 2007, I was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. I also managed the internal profit sharing and charitable endowment monies of the firm. From 2003-2007, I was a leading commentator at the investment website RealMoney.com. Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and I wrote for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I no longer contribute to RealMoney; I scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After three-plus year of operation, I believe I have achieved that. Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life. My background as a life actuary has given me a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that I will deal with in this blog. I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.