Bernanke’s Advice: More Emphasis on Data, Less on Fed Guidance

Former Fed Chair Bernanke keeps a blog at
  His latest
offers insight into how to think about Federal Reserve, and in
particular, Fed officials’ understanding of the US economy.  

Bernanke’s beginning point is the long-term
forecasts of the Summary of Economic Projections–the last dots in the dot
  There are three forecasts that are
, GDP, unemployment and Fed funds. The shorter-term forecasts are an
assessment of where the economy is going in the current cycle, while the
longer-term forecasts are more about structural relationships.  

Bernanke argues that the long-term dot plot
for GDP is a judgment about the potential growth.
  It is not within
the control of monetary policy.  In
the long-run, it is about population
growth and productivity.  The long-term forecast for unemployment is an assessment of the “natural” rate or the non-inflationary level.  It is
a function of a variety of factor, including the number of workers, skill sets,
and labor costs.  The long-term forecast for Fed funds is the terminal
rate or the neutral level.  Besides inflation, Bernanke suggests the
neutral level for Fed funds is influenced by the rate of return on capital and
the supply of savings, for example.  

There is a clear trend in the Fed’s thinking. 
The changes in the Fed’s views have been in the direction of lower potential
growth, a lower ‘natural’ rate of unemployment and a lower neutral rate for Fed
funds.  Specifically, in the last four years, the long-term growth
projection has fallen to 1.8%-2.0% from 2.3%-2.5%.   The ‘natural’
rate of unemployment has fallen to 4.7%-5.0% from 5.2%-6.0%.  The neutral
rate of Fed funds has been cut from 4.25%
from 3.0%.  

Bernanke candidly admits what is behind the
changes in the Fed’s thinking:  persistent errors in economic forecasting.
Productivity growth has slowed considerably.  Also, Bernanke points out that the slower growth at the same time
that unemployment has fallen faster than expected can be reconciled under Okun’s Law by less
potential growth.  

Low observed inflation and the decline in
unemployment can be reconciled if the
natural rate of unemployment is lower than previously understood. 
lower equilibrium or terminal rate for Fed funds is, in part, a function of lower
growth potential as it implies a lower return on capital.  In turn, the lower equilibrium rate can also
help explain the sluggishness of actual output growth, as it implies that
current policy is not as stimulative as thought.   

Bernanke also notes that Fed officials take
into account the long-term interest rates that are set by the market.

  The low long-term may imply that
anticipate an extended period of low real returns, low
inflation (which means low nominal returns)  and low-risk premiums on safe forms of debt. Together these suggest
lower Federal funds rate in the long run.

There are two general takeaways from Bernanke’s commentary.  First, the downward
revisions to the long-term forecast imply that on balance, Fed officials see policy as less accommodative than previously,
the labor markets are not as tight and price pressures more constrained.  
This speaks to a slower pace of
normalization of US monetary policy.  Second, Bernanke cautions Fe-
watchers:  They “should probably focus on incoming data and count a
bit less on Fed policymakers for guidance.”


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