Doing nothing never did more. ? Time for the quarterly examination of the composite views of the Federal Open Markets Committee, along with some choice comments on its chief partner-in-crime, the ECB. Ready? Let’s go!
In August, Mohnish Pabrai took part in Brown University's Value Investing Speaker Series, answering a series of questions from students. Q3 2021 hedge fund letters, conferences and more One of the topics he covered was the issue of finding cheap equities, a process the value investor has plenty of experience with. Cheap Stocks In the Read More
Now, I promised a look inside the minds of the FOMC, and hypothetically, that what this will be. To begin that, you have to recognize the four regularities of FOMC forecasts, as they might think about it:
- We overestimate GDP growth
- We underestimate labor unemployment
- We overestimate PCE inflation
- We overestimate the Fed funds rate
You might ask why they think that way, and if you administered the truth serum, they might say: “We believe the neoclassical view of macroeconomic theory. We know that Fed policy will work, and so we act like we are in control, when we are something in-between being Sorcerer’s apprentices and clinically insane. We keep doing the same thing and expect a different result.”
Okay, some of that last bit wasn’t fair, at least not fully. There *are* some processes where until you do a critical amount of effort, the expected result doesn’t happen. But textbook monetary policy isn’t supposed to be that way.
So, take a look at the above GDP predictions graph. The “slope of hope” points downhill as the economy does not grow as quickly as they thought it would, given all of their efforts.
The unemployment was similar, except here, they weren’t optimistic enough. As it is, they expect unemployment to remain low for a long time, at about the levels that it is now. Now, how likely is it for unemployment rates to remain stable for three years? Not that likely.
You can almost hear them thinking, “Inflation will come back to 2%. After all we’ve been so loose for so long. There’s no way it should remain so low when we are creating credit left, right, up, down, forwards and backwards.” But then, it doesn’t come — it always stays low. Their long run view stays stubbornly at 2%, unlike other views where they let it drift, and that’s because 2% inflation is the religion of the Fed! It is the Holy Received Goal, that proper monetary policy will create.
But sometimes they wonder, when it’s dark at night and quiet, “What would it take to create inflation? What?”
Finally, they all know that the Fed funds rate will rise. It can’t stay low forever, can it?
Behind it all is the nagging worry: “Why doesn’t economic activity pick up?! We’re doing everything we can short of doing a helicopter drop of money! That has to be enough! We don’t want to go to buying investment grade corporates or negative interest rates like that basket-case, the ECB, at least not yet. C’mon grow! Grow!”
Note that for each quarter the FOMC has given its projections recently, they have thrown a quarter-percent tightening out the window. That’s how overly optimistic they are in setting estimates of future policy.
Leave aside the fact that various risk assets in fixed income land are now flying. High-yield isn’t doing badly, but emerging markets debt is taking off — note $EMB which has recently broken its 200-day moving average.
Bad theories beget bad policy tools, which in tern begets bad results. The FOMC needs an overhaul of its theories, so that it stops creating speculative bubbles, and learns to be happy with an economy that just muddles along. And who knows? Give savers a fair rate of return, and maybe the economy will grow faster.