Forecasting Errors result from “Inappropriate Monetary Policy”

In “Persistent overoptimism about economic growth” Kevin Lansing and Benjamin Pyle of the San Francisco Fed give a try at finding explanations:

Since 2007, Federal Open Market Committee participants have been persistently too optimistic about future U.S. economic growth. Real GDP growth forecasts have typically started high, but then are revised down over time as the incoming data continue to disappoint.

Possible explanations for this pattern include missed warning signals about the buildup of imbalances before the crisis, overestimation of the efficacy of monetary policy following a balance-sheet recession, and the natural tendency of forecasters to extrapolate from recent data.

I think the key is in the highlighted “explanation”. They go on to consider:

According to the Summary of Economic Projections (SEP), “each participant’s projections are based on his or her assessment of appropriate monetary policy.” A possible explanation for the SEP’s prediction of a rapid catch-up to potential GDP after 2009 is that participants overestimated the efficacy of monetary policy in the aftermath of a so-called balance-sheet recession. Recessions triggered by financial crises are typically preceded by sustained episodes of bubbly asset prices and debt-financed spending booms. When the bubble bursts, the resulting debt overhang forces borrowers to repair their balance sheets via reduced spending or default. Borrowers have too much debt, so monetary policy actions designed to encourage more borrowing by lowering interest rates are less effective.

What do they mean by “appropriate monetary policy (AMP)” about which participants have to make an assessment? Is an “AMP” one that keeps inflation on target?  It didn´t.

If the “design” of monetary policy is “defective”, don´t fiddle with it, change the “design”. An “all weather design” widely suggested by market monetarists is to make MP strive to gain and maintain NOMINAL STABILITY!


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