The Fed – Clueless, Delusional, or Both?

This article is an excerpt from the Wall Street Examiner Professional Edition Fed report of 7/17/10. It is still timely. It will always be timely as a reminder of the Fed’s absence of comprehension

The Fed is in La La Land, unwilling or unable to see reality and uncertain about what to do for its next act. It will remain frozen like a deer in the headlights until another crisis puts Bernanke and Co. into panic mode where they will overreact and do something to make the situation worse.

I pulled the following key paragraphs from the minutes of last month’s FOMC meeting so that you can get a sense of how the Fed thinks.

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In the economic forecast prepared for the June FOMC meeting, the staff continued to anticipate a moderate recovery in economic activity through 2011, supported by accommodative monetary policy, an attenuation of financial stress, and strengthening consumer and business confidence. While the recent data on production and spending were broadly in line with the staff’s expectations, the pace of the expansion over the next year and a half was expected to be somewhat slower than previously predicted. The intensifying concerns among investors about the implications of the fiscal difficulties faced by some European countries contributed to an increase in the foreign exchange value of the dollar and a drop in equity prices, which seemed likely to damp somewhat the expansion of domestic demand. The implications of these less-favorable factors for U.S. economic activity appeared likely to be only partly offset by lower interest rates on Treasury securities, other highly rated securities, and mortgages, as well as by a lower price for crude oil. The staff still expected that the pace of economic activity through 2011 would be sufficient to reduce the existing margins of economic slack, although the anticipated decline in the unemployment rate was somewhat slower than in the previous projection.

In their discussion of the economic situation and outlook, meeting participants generally saw the incoming data and information received from business contacts as consistent with a continued, moderate recovery in economic activity. Participants noted that the labor market was improving gradually, household spending was increasing, and business spending on equipment and software had risen significantly. With private final demand having strengthened, inventory adjustments and fiscal stimulus were no longer the main factors supporting economic expansion. In light of stable inflation expectations and incoming data indicating low rates of inflation, policymakers continued to anticipate that both overall and core inflation would remain subdued through 2012. However, financial markets were generally seen as recently having become less supportive of economic growth, largely reflecting international spillovers from European fiscal strains. In part as a result of the change in financial conditions, most participants revised down slightly their outlook for economic growth, and about one-half of the participants judged the balance of risks to growth as having moved to the downside.

Moreover, several participants observed that the decline in yields on Treasury securities resulting from the global flight to quality was positive for the domestic economy; in particular, the associated decline in mortgage rates was seen as potentially helpful in supporting the housing sector.

Mortgage rates have not boosted housing one iota. The data which I’ve presented in the Wall Street Examiner Professional Edition Housing Report is absolutely clear on that. Lower mortgage rates aren’t helping and they aren’t going to help. The only thing that will help is more jobs to reverse the negative trend in household formation. And contrary to what the Fed says, the labor market isn’t improving.

Participants commented that household spending continued to advance, with notable increases in auto sales and expenditures on other durable goods. Going forward, consumption spending was expected to continue to post moderate gains, with the effects of income growth and improved confidence as the economy recovers more than offsetting the effects of lower stock prices and housing wealth.

More delusions. Increased consumer confidence? The Michigan ConCon survey out Friday put that one to rest. Consumer confidence, as we’ve seen time and again, follows either the stock market or the housing market. If one or the other is going down, concon goes with it.

The economic outlook had softened somewhat and a number of members saw the risks to the outlook as having shifted to the downside. Nonetheless, all saw the economic expansion as likely to be strong enough to continue raising resource utilization, […glass always half full group think mentality] albeit more slowly than they had previously anticipated. In addition, they saw inflation as likely to stabilize near recent low readings in coming quarters and then gradually rise toward more desirable levels. In sum, the changes to the outlook were viewed as relatively modest […more timid group think. No one wants to be too far out of step.] and as not warranting policy accommodation beyond that already in place.

However, members noted that in addition to continuing to develop and test instruments to exit from the period of unusually accommodative monetary policy, the Committee would need to consider whether further policy stimulus might become appropriate if the outlook were to worsen appreciably. [ … the too much too late syndrome] Given the slightly softer cast of recent data and the shift to less accommodative financial conditions, members agreed that some changes to the statement’s characterization of the economic and financial situation were necessary. Nearly all members judged that it was appropriate to reiterate the expectation that economic conditions–including low levels of resource utilization, subdued inflation trends, and stable inflation expectations–were likely to warrant exceptionally low levels of the federal funds rate for an extended period.

There it is at the end—the master delusion that a few word changes will make a difference in the economy. How can anyone take this nonsense seriously? It’s unbelievable.

Just how clueless are these people? Here’s a little exercise to illustrate. Below is a series of graphs showing the Fed’s grasp of the economy over the past several years. At each FOMC meeting the 5 Fed Governors and 12 District Bank Presidents are surveyed as to their expectations. The results are tabulated and presented in graphical form. Below are the results for forecasts of GDP and Unemployment. Their record on inflation (not including asset prices of course) has been pretty close to the mark, so there’s no need to review that data. The date of the meeting is shown above each pair of charts, with my comments below.

October 30-31 2007

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Real GDP Growth for 2008 was -3.3%. None of the Fed Governors or District Bank Presidents saw that coming. Not a single one!

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1 year after this meeting, the Unemployment Rate was 6.6%. At year end it was 7.4%. The average for the year was 5.8%. Not one of the Fed Governors or District Bank Presidents saw it being that high.

June 24-25 2008

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9 months later, even when they were right in the middle of the recession, not a single Fed Governor or District President was able to judge its severity. All were predicting just under 1% growth, not even close to the 3.3% actual decline. They were overestimating GDP and underestimating unemployment.

October 28-29 2008

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They had the same lack of vision even after the stock market had crashed in October, having no clue as to the depth of the recession already well under way. Then they underestimated GDP growth for 2009, when it actually grew by 2.4%. Not a single FOMC member had it that high. However, they completely missed the unemployment rate on the low side. The average rate for the year was 9.3%. None of them had it higher than 8%. Not one had it right! They were wrong on total economic growth, and wrong on unemployment, in opposite directions? They weren’t just wrong on average. Every single one of them was wrong on both accounts. This is beyond random. It tells us that their models simply do not work. They are designed in such a way that if they can’t give the right answers.

January 27-28 2009

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They got even worse on GDP in early 2009. Not a single member foresaw growth for the year, let alone 2.4%, the actual growth rate for the year. And yet they were still underestimating employment.

April 28-29 2009

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They finally guessed right on employment for the year 2009 by the end of April with 4 months of the year already done. They still did not understand the impact of their policies, however, still grossly underestimating GDP growth. Again, not a single Fed Governor or District Bank President got it right.

June 23-24- 2009

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Did they get it by mid year? Nope, but they had gotten very bullish on 2010. Will they be right? I wouldn’t bet on it. As for long term forecasts, if they can’t even guess the short term correctly, we should give any weight to their longer term forecasts? As far as I can tell the FOMC members are engaged in mental masturbation. It may make them feel good, but as a tool for making monetary policy, it’s a complete waste.

This little exercise shows that the Fed is not only clueless, but probably even delusional, since they even refuse to see the obvious. They see nothing, they hear nothing, they know nothing; and then, when the conflagration surrounds them, they react with too much, too late. Once they’ve had their fun, not knowing what is happening or what will happen, they then go back to their old behavior of doing nothing at the level of the last policy action until the economy blows up around them again. Then they begin a new round of too late, over-reactive policy actions.

This willy-nilly, ad hoc, crisis reaction brand of central banking is a disgrace, a scourge on our nation and the world. Why should we give any credence to their current views? We should not. With that in mind check out their current range of forecasts below, in other words what NOT to expect for the next year.

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June 22-23 2010

The unemployment rate is a red herring anyway. What’s important is the total number of jobs in the economy. Even as the unemployment rate has remained stable, the total number of employed continues to shrink. The government, in its infinite wisdom, removes just enough numbers from the labor force count to keep the unemployment rate stable. The Fed isn’t even playing the right game, let alone hitting the right target.

Oh the absurdity!

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