Posted by: mulrickillion | March 2, 2012

Why We Can’t Believe the Fed

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Federal Reserve System headquarters, Washington, DC; Photo by M. Ulric Killion.

Author: Benn Steil, Senior Fellow and Director of International Economics
Council on Foreign Relations, Feb 22, 2012
Op-Ed, Wall Street Journal

The Federal Reserve’s interest rate-setting Open Market Committee recently broke new ground in Chairman Ben Bernanke’s transparency campaign by proffering predictions of its own behavior over the next three years. This is a huge innovation for the Fed, which has never predicted economic data it directly controls. . . .

In short, the Fed’s premise that it can speak with authority about the future is flawed. During the two decades to 2006, its own experts were worse than outside ones in predicting one-year economic data. Since the start of the crisis in 2007, its three-year predictions have been worthless.

This means Mr. Bernanke’s new transparency campaign actually injects significant new risks into the business of Fed-watching. Earlier Open Market Committee statements carried a warning that "future policy adjustments will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information." The Fed is now saying something entirely different: that it is confident that incoming information will not materially change the Fed’s current expectations—which justifies keeping policy constant over the next three years.

Yet since history flatly contradicts the notion that the Fed can safely pledge interest rates three years out, there is a significant likelihood that the credibility of the Fed’s new inflation target will crumble, as it keeps interest rates down despite rising prices, or that its effort to persuade the market that rates will stay near zero will end in shambles. . . .

Why We Can’t Believe the Fed – Council on Foreign Relations

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