The “Teal Book”:
Rest in peace, Green Book and Blue Book. The Federal Reserve‘s confidential briefing books that policymakers have used for decades received an overhaul for the Federal Open Market Committee meeting that begins today. The new document merges the two prior books, named for the color of their covers, into one: the Teal Book.
The “Teal book” is released with a five year-lag, just like the transcripts. We have now access to the December 2010 Teal Book or “Report to the FOMC on Economic Conditions and Monetary Policy”
As you would expect, it´s a long (100 pages) document. What caught my eye was the “Long-Term Outlook” on page 32. The panel below sets out the Outlook (Forecast) for Real Output Growth, Unemployment Rate, Headline & Core PCE Inflation, Effective Federal Funds Rate and 10-year Government Bond Yield.
The growth rates are Q4/Q4 rates while for Unemployment, FF Rate and Bond Yield it´s the Q4 average for each year.
Two things caught my eye:
- The large forecast errors, mostly with the same sign
- The almost perfection of the unemployment rate forecast
Is there a worldview (model) consistent with those forecasts? A nice candidate would be a Phillips Curve worldview.
Imagine that the FOMC were pretty confident in their unemployment rate forecast. Via “Okun´s Law”, a falling unemployment rate would be consistent with a rising RGDP growth. Via the Phillips Curve, a falling unemployment rate would also be consistent with an initially very low inflation rate, especially a low core inflation rate unburdened by oil price increases (that were taking place at the time the forecasts were made), reflecting the initial extremely low utilization rate. Over time, inflation would rise to reflect labor market tightening.
With that, the policy rate (FF) would start to “normalize” and long-term bond yields would rise in accordance with both higher real growth and higher inflation.
The results, however, contradicted the worldview. Unemployment fell almost exactly as forecast. However, real growth never picked up. Initially, core inflation was much higher than expected and dropped significantly over time. The exact opposite of the FOMC´s forecast.
With no increase in real growth and with inflation far below “target”, policy “normalization” was not an option! That is, until the FOMC couldn´t hold itself any longer, raising the FF rate in December 2015.
Policy tightening, however, began much earlier, in mid-2014, with the start of Fed “talk” of raising rates. Not surprising that at that point commodity prices turned down and the dollar began to rise.
It´s way past the time the FOMC changes it´s “worldview”!
Update: Bullard says:
The U.S. central bank’s inflation and employment goals have essentially been met and it would be “prudent” to edge interest rates higher, St. Louis Fed President James Bullard said on Friday.
You could say they have (even with core inflation a bit below target). As you see from the forecasts made in 2010, the targets would have been “met” only with much higher rates. Maybe that´s why he uses the word “prudent”. Does he feel they were “lucky” to “meet” the targets with rates far below the ones “deemed” necessary originally?
Or does the outcome imply that interest rates are irrelevant? In that case, what would be the relevant monetary policy measure? What is the “alternative” policy measure indicating?