A James Alexander post

As the FOMC increasingly avers that it is data-driven the demand to have better data has led to greater focus on aggregated current data. Whether the FOMC really looks at it, given it is ignoring its own Labour Market Conditions Index, is hard to say.

However, we now have two “nowcasts”. Supplementing the accurate Atlanta Fed the boffins at the NY Fed have decided to introduce their own. It is hard to see exactly why they have done it except maybe out of pique. There seems to be a hint that the Atlanta Fed is a bit too short-termist, judging by the spin to journalists around its launch. GDPNow tries to forecasts the first release of GDP, the one that lacks much of the “third month” data but is still taken very seriously. It is accurate as far as it goes in my mind, taking the trend from the previous quarter and adding up-to-date figures as they are released, and inevitably has a bias towards the first two months of the quarter.

By the time second and third estimates of quarterly GDP have been released using the “second month” revised data and the “third month” new data, GDPNow has moved on to start forecasting the following quarter. If the GDPNow model had kept on running using the additional component data it would probably accurately predict the revisions to GDP, but that would not be the point of it.

The NY Fed seem to want to forecast revised GDP numbers and also go one further and forecast both the unreleased quarter and the current quarter – i.e. they are forecasting right now both 1Q and 2Q 2016. And will continue to do so until the third and final estimate of 1Q is available. By such means they are trying to be a bit more long term in their use of trends. So they were fairly snooty about how their 1Q16 on its first showing was at 1.1% versus Atlanta’s down at 0.1%. their forecast for 2Q16 was a whopping 1.9%.

So it was a bit embarrassing this week that data led to large downgrades to just 0.8% for 1Q16 and to just 1.2% to the mysteriously optimistic 2Q16 – implying some bias towards some sort of longer term trend or mean reversion – disrupted by downbeat actual data. It would be great if they also nowcast the more important, and more reliable “nowcastable”, nominal GDP.

The Atlanta Fed model is actually more sophisticated than many realise. It sometimes seems more volatile because, as is common in the US, it nowcasts annualised QoQ growth.

Why the US focuses on QoQ growth is a bit of a mystery to the rest of the world that tries to focus on YoY growth each quarter. Annualising QoQ means multiplying the growth rate by four so that any minor error in the quarter appears much greater, 4x greater, than it really is.

Also, the Atlanta Fed nowcasts less volatile national output statistics that exclude changes in inventories (ie the final sales GDP figure) and one that excludes both changes in inventories and the impact of net exports (final sales to domestic purchasers). Final sales is nowcast to grow at 0.9% QoQ annualised for 1Q16 due to the exclusion of the big run-down in inventories which reduces the investment element of GDP. Final sales to domestic purchasers is nowcast to grow at 1.6% as it excludes both the inventory run down and the trade deficit.

It will be fun to watch this “battle of the nowcasts” as we know well that despite promises of zero subjectivity the underlying models of the Fed use a Philips Curve approach that sees rapid inflation at current levels of unemployment, despite tight money.

The FOMC & its Forecasts

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.

Teal Book_1

Teal Book_2

Two things caught my eye:

  1. The large forecast errors, mostly with the same sign
  2. 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?

His Excellency, the Model, suggests…

The Federal Reserve Board released an updated version of its large-scale model on the U.S. economy that may hold clues into why policy makers pivoted at their meeting earlier this week toward a December interest-rate increase.

The revised inputs and calculations on Friday suggest the economy will use up resource slack by the first quarter of 2016, according to an analysis by Barclays Plc, and that also indicates Fed staff lowered their near-term estimate for how fast the economy can grow without producing inflation — a concept known as potential growth…

…In the current model, “the long-run growth rate is two-tenths lower” at 2 percent, Barclays said. FOMC participants forecast the economy’s long-run growth rate at 2 percent in September.

The unemployment rate stood at 5.1 percent in September, and the Fed model assumes little change from that level, dipping to a low of 4.8 percent in a forecast horizon that extends to 2020, according to Barclays. FOMC officials estimated full employment — or the level of the unemployment rate consistent with stable prices — at 4.9 percent last month…

…The model, known as FRB/US and updated periodically, is a series of calculations put together by Fed staff that sketch out how broad measures of the economy would change based on a set of defined parameters. The staff also constructs a bottom-up forecast for policy makers before each FOMC meeting. U.S. central bankers use the models and forecasts as reference points, not sole determinants of their decision-making.

This is nothing short of fantastic!

For the past five years, since partially recovering from the “Big Slump” of 2008-09, real output (RGDP) has been crisscrossing the “potential” growth rate. On the last view, it seems to be dying to undercrosss it! From the behavior of NGDP growth, it will likely “manage” that over the coming quarters.

FRB-US Model_1

Meanwhile, unemployment has taken a dive, but that has not put upward pressure on any measure of inflation, that has been “relenting” (and doing so long before the oil price drop since mid-2014).

FRB-US Model_2

Maybe the future will be significantly different from the recent past, with, for example, low unemployment finally pressuring inflation according to the Fed´s preferred Phillips Curve assumption in the model, given that real growth is (and has been for a long time) at “potential”.

However, before putting a lot of faith in these forecasts, what is the model´s “record of accomplishment”?

The tables below start with the first “Forecast Material” from April/11. Then from March/13, March/14 and the latest from Sept/15. In parenthesis, the realized value for the year. You immediately notice the “one-sided” errors of the forecasts, which mostly over forecast growth, unemployment and inflation!


RGDP Unemploym. PCE PCE-Core
2011 3.2 (1.6) 8.6 (8.5) 2.5 (2.5) 1.5 (1.5)
2012 3.4 (2.2) 7.8 (7.9) 1.6 (1.9) 1.5 (1.9)
2013 3.9 (1.5) 7.0 (6.7) 1.7 (1.4) 1.7 (1.5)


RGDP Unemploym. PCE PCE-Core
2013 2.6 (1.5) 7.4 (6.7) 1.5 (1.4) 1.6 (1.5)
2014 3.2 (2.4) 6.9 (5.6) 1.8 (1.4) 1.9 (1.5)
2015 3.4 (?) 6.3 (?) 1.9 (?) 2.0 (?)


  RGDP Unemploym. PCE PCE-Core
2014 2.9 (2.4) 6.2 (5.6) 1.7 (1.4) 1.5 (1.5)
2015 3.1 (?) 5.8 (?) 1.8 (?) 1.8 (?)
2016 2.8 (?) 5.4 (?) 1.9 (?) 1.8 (?)


RGDP Unemploym. PCE PCE-Core
2015 2.1 5.0 0.4 1.4
2016 2.3 4.8 1.7 1.7
2017 2.2 4.8 1.9 1.9
2018 2.0 4.8 2.0 2.0

Notice how they have been “downgrading” their growth and unemployment forecast over time, but not fast enough to catch up with “reality”. Notice how their inflation forecasts will always move towards the target. They must be greatly frustrated!

I certainly wouldn´t bet the house on the model´s robustness (or precision)!