In November 2007, the US Federal Reserve Bank began publishing quarterly forecasts for GDP growth. Since then, every single one of its projections has been too optimistic about the US economy.
This isn’t just embarrassing for the Fed’s prognosticators: University of Berkeley economist Brad Delong thinks this overoptimism could be harming the economy. Delong, a former assistant secretary at the US Treasury, writes on his blog that Americans should be “gravely worried” that the Fed has been prematurely raising interest rates based on rosy projections. The country is losing needed monetary stimulus as a result.
So, how far off has the Fed been?
Quartz compiled the Fed’s projection made towards the beginning of each year since 2008, and compared that with what actually occurred. Each projection is an estimate for GDP growth in the forthcoming three years. (Technically, the estimate is the midpoint of the Fed’s central tendency for GDP growth.)
The chart below shows how far off the Fed was in each year. For example, at the beginning of 2008, the Fed projected 2008 GDP growth of 1.65%, but in actuality it was -2.8%, so we have them as off by +4.45 percentage points. On average, since 2008, the Fed overshoots annual GDP growth by 1.2 percentage points, with overoptimism the highest for projections farthest into the future.
Why has the Fed been so mistakenly buoyant?
Federal Reserve Bank of San Francisco economists Kevin Lansing and Benjamin Pyle, who are not involved in the Fed’s GDP predictions, examined this persistent overoptimism in 2015—observers have been aware of the phenomenon for several years. They suggest that the Fed’s board members may be overestimating their own powers. That is, officials likely expected that slashing interest rates and buying bonds would lead to a more robust recovery. In actuality, say Lansing and Pyle, monetary stimulus may not help much when a recession is caused by a financial crisis, because in that case borrowers already have too much debt and aren’t helped by easier credit.
Even though the US economic recovery has been sluggish, the Fed continues to slowly raise interest rates. This is primarily because most of the members of the Federal Open Market Committee, the group of Fed board members who vote on setting interest rates, believe the economy is near full employment. They are worried that keeping interest rates low might risk an overheating economy and high inflation. (The Fed has also consistently overestimated inflation in recent forecasts.)
Given the Fed’s track record, it is worth questioning this logic. If policymakers are still overestimating the strength of the economy, they may be trying to hold it back when it actually still needs a helping hand.