A Look Inside the Minds of the FOMC

Picture Credit: TZA

Picture Credit: TZA

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!

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GDP graph

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:

  1. We overestimate GDP growth
  2. We underestimate labor unemployment
  3. We overestimate PCE inflation
  4. 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.

Unemp graph

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.

PCE Inflation

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?”

FF graph

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.

Updated on

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.
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