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Wednesday, November 21, 2007

The New Fed Forecasts

The Fed released its "new and expanded forecast":

Fed Forecasts Emphasize Risks, by Greg IP: Federal Reserve officials, in a new and expanded forecast, expect the nation's economy to grow sluggishly next year and see risks of an even worse performance.

They also expect food and energy prices to continue putting upward pressure on inflation, but say underlying inflation is now, and will remain, within the target range implied by their new forecast.

The enhanced forecasts by officials of the Fed's policy-setting Federal Open Market Committee underline the conflicting pressures on the central bank to cut interest rates to protect economic growth or to hold them steady to quell inflation. ...


The Fed appears to put the economy's "potential" growth rate -- what it can achieve given long-term growth in the work force and output per worker -- at a mere 2.5%, well below the average annual growth of 3.1% recorded over the past 12 years and the Congressional Budget Office's 2.9% estimate of potential growth. That means a growth rate that others consider substandard might be viewed as healthy, or even inflationary, by the Fed.

FOMC members expect overall inflation, measured by the price index for personal-consumption expenditures, of 1.8% to 2.1% next year, reflecting continued upward pressure from rising energy and food prices. They expect core inflation, which excludes those two factors, of 1.7% to 1.9%. With core inflation now 1.8% and expected to remain there, the Fed isn't under pressure to push it lower.

By 2010, the Fed official said they expect overall and core inflation between 1.6% and 1.9%. Given that Fed officials expect to be able to achieve their desired inflation rate within three years, this range is the Fed's de facto inflation target. The 1.75% midpoint of this range is higher than that of the 1% to 2% comfort zone popularized in 2002 by Ben Bernanke, then a Fed governor...

The minutes, and an accompanying study by staff economists David Reifschneider and Peter Tulip, emphasize that projections are subject to a lot of forecasting error, and those errors grow the further the forecast goes into the future. Based on the track record of forecasts, they say there's a 70% chance growth will be 1.3 percentage points higher or lower than the FOMC forecasts next year, and 1.4 points higher or lower in subsequent years.

See also (1) Dovish Fed vs. Hawkish Fed: More on the FOMC Minutes and Fed’s New Forecasts: What’s Surprising and What Isn’t for more from the WSJ; and (2) So now you know by Jim Hamilton who is surprised by the three year ahead forecasts for relatively low output growth, as well as the forecast for relatively low inflation.

    Posted by on Wednesday, November 21, 2007 at 12:24 AM in Economics, Monetary Policy | Permalink  TrackBack (0)  Comments (6)


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