Austan Goolsbee On The Fed’s Broken Forecasting Model

June 28, 2016

by Justin Kermond

Austan Goolsbee is optimistic that the long-run prospects for the U.S. economy are outstanding due to the unbounded strength of our human capital, innovation and entrepreneurialism. However, Goolsbee warned that the next 12-18 months will be bumpy and the illusive V-shaped recovery will not happen because the U.S. Federal Reserve “forecasting model is broken, [and] if you are waiting for the 2006 normal bus to come back and pick you up and take you back to prosperity, you are actually hitch-hiking because the bus is not going to come back”.

Goolsbee is the Robert P. Gwinn professor of Economics at the University of Chicago’s Booth School of Business and serves as a strategic partner at 32 Advisors, a global consulting and advisory firm. He previously served as a member of the Obama cabinet and as chairman of the Council of Economic Advisers, as well as the chief economist for the President’s Economic Recovery Advisory Board. He spoke to an audience of advisors as a keynote speaker at the Morningstar Investment Conference in Chicago on June 14th.

The Fed’s broken forecasting model

Goolsbee asserted that the Fed’s broken forecasting model has resulted in 30 quarters in a row of “serially correlated errors” resulting from the Fed’s unrealistic expectations that the U.S. economy can return to the go-go days of 2006. The Fed repeatedly predicted a 3% growth rate, and the actual results were a 2% growth rate with a different follow-up excuse each quarter. Those excuses ranged from the winter being too cold to an earthquake in Japan to the British threatening to exit the European Union. Goolsbee said the Fed has “established a totally credible ridiculousity of non-credibility.” Goolsbee said that none of these excuses are valid and that the next 12-18 months “are not going to be that great,” but he does not think the economy is at risk of overheating or hyperinflation. Goolsbee said the economy will continue at a modest 2% growth rate.

The root of the problem is the broken model that unrealistically assumes that the return of the housing market, an increase in consumer spending, the drop in the price of oil, the political system and the Fed can lead the U.S. economy to the next V-shaped recovery, according to Goolsbee.

What it takes to have a V-shaped recovery

Goolsbee said that the economy has grown at a modest rate for an extended period of time, but the growth rate has consistently disproven what the Fed has been predicting. Goolsbee explained that the Fed’s predicted V- and then U-shaped recoveries never emerged because the Fed was waiting for a savior to lead us to recovery and “the savior never showed up.” The Fed defines normal as 2006, but 2006 is not going to happen again because it was an unsustainable bubble period. Goolsbee explained that V-shaped recoveries in the U.S. have only occurred when the economy could return to the same economic growth engines that were generating economic growth prior to a recession. In the case of our most recent recession, the U.S. could not return to an economy based on housing investment and consumer spending. Instead, we have had to steer our economy toward a more export-, capital investment- and innovation-oriented growth, which cannot happen as a V-shaped recovery. This is a much slower process of adjustment, as it requires industries to retrain its workers and relocate them from areas without to areas with jobs.

Why the U.S. housing market is not the short-term savior

Goolsbee explained that when looking at the last 109 years of U.S. housing price data, the first 90 years showed housing prices appreciating at a modest 30 to 40 basis points per year. But an 8-year period starting in 1998 followed where housing prices grew at 13.5% annually. The Fed and other economists have repeatedly predicted a much higher rebound growth rate in the housing market than has actually happened. The Fed predicted higher rates of people buying houses, new housing starts and associated construction booms than actually materialized. Goolsbee said this is because the Fed model is broken just “like our brains as the model is implicitly waiting for things to go back to normal” and the Fed’s model defines normal as 2006 data. Goolsbee said this is an incorrect assumption because the 2006 data was in an unsustainable bubble period, and housing will not grow at that rate again but will resume being a positive contribution to GDP with a more modest growth rate.

PDF | Page 2

Federal Reserve Fed

The Fed’s Broken Forecasting Model