What’s up with the markdowns?

June 19th, 2015 at 11:35 am

The figure below shows a series of forecasts by the Federal Reserve for real GDP growth in 2015, with the first forecast made in March 2013 and the last one made a few days ago. Each bar shows the central range of the forecasts by Fed economists, with the average forecast as a dot in the middle of each range.


Source: Federal Reserve

The punchline, as you see, is that the closer we’ve gotten to the actual outcome for GDP growth this year, the more they’ve marked down their previous guesstimates. Back in early 2013, they thought we’d be cooking along at 3.3%, and if anything, their “north-of-three” forecast became stronger as time went on, as seen by the narrower range around the average.

Then, as reality set in and faster growth turned out not be around the next corner, their forecasts came down a bit. Still, they thought ample growth rates just shy of 3% were awaiting us this year.

Except they weren’t, and the markdowns continued and got bigger, with the most recent one taking their 2015 guesstimate from 2.5% down to 1.9%. As the NYT crisply put it, “In a retreat that has become a ritual for the overly optimistic central bank, officials said in a new round of economic forecasts published Wednesday that they expected the economy to grow this year by 1.8 percent to 2 percent.”

Now, to be clear, this isn’t meant to pick on the Fed forecasters, who are no better or worse than most others. You can see this same pattern in the forecasts of the IMF, the World Bank, CBO, and the National Association of Business Economists.

What’s interesting here are the two questions this raises: 1) what’s driving these markdowns? What’s going on in the economy that top forecasters keep systematically missing, and 2) Why aren’t the forecasts self-correcting? Why do they keep trusting Lucy to hold onto the football?

Re the first question, there are numerous perps that have contributed to the markdown pattern.

–Bad fiscal policy: While we’re not Europe, we too pivoted to deficit reduction too soon. The figure below, from Goldman Sachs researchers, shows the impact of fiscal policy on GDP growth, 2009-15. In 2009, the Recovery Act did some heavy lifting, but it quickly faded (despite President Obama’s efforts to do more) and in 2013, fiscal policy was a big negative on growth and jobs. The fiscal growth impulse has shifted into neutral for now, and I suppose “do no harm” is the most we can expect from the current Congress. But there’s no question that our subpar growth has been a function of unlearning lessons about the need for supportive fiscal policy in weak economies.


Source: Goldman Sachs

–Weak investment: Both public and private investment has been subpar in recent years, with the latter feeding back negatively into productivity growth, as Larry Mishel shows—quite dramatically—here. In terms of our transportation infrastructure, according to the most recent World Economic Forum rankings, the U.S. fell from 7th to 18th in the quality of our roads over the past decade, as our investments in this space have declined by half as a share of GDP since the 1960s. I should note here that the Republican budget resolution calls for a 40% decline in transportation funding.

–Deleveraging and the reverse wealth effect: I’ve written in lots of places how debt bubbles, like those involving mortgages, take a lot longer to work through then equity bubbles. Basically, your shares in Pet Rocks, Inc., get marked to market quickly, while banks holding non-performing loans can “extend-and-pretend” ad nauseam. Interestingly, Chair Yellen has often made this point herself, referring to this dynamic as a persistent and ongoing headwind. To be fair—and this gets a bit into question #2 (why are the models systematically wrong)—no one really knows the timing of how this kind of dynamic plays out in the macroeconomy.

–Inequality and the decline in the compensation share of national income: Economist Joe Stiglitz has argued that the extent of income inequality has also hurt growth in ways the models underweight. If you’re just thinking about averages, you may miss the fact that while average income has gone up, median income has gone up a lot less—this is a symptom of inequality. In the same vein, the share of national income going to paychecks versus profits is around a 50-year low.

The germane factor here re growth is that those with higher propensities to spend the marginal dollar are seeing fewer dollars flow their way, while those who are anything but liquidity constrained—the very wealthy—are bathing in the stuff. As I note below, the housing bubble and its wealth effect offset this dynamic in the 2000s. But not now.

–Congressional dysfunction: IMHO, this is a bigger deal than people think. It’s de rigueur to say stuff like, “well, as long as Congress is tied up in ideological knots, they can’t mess stuff up.” But, in fact, that’s just wrong. First, businesses can’t plan ahead if they don’t know what’s happening with tax issues like bonus depreciation and other such “extenders.” Second, as a colleague who watches both governments and markets pointed out to me, the return on government investments is lower when it’s made at the last minute, without adequate planning. Again, think of highway and mass transit spending. And of course, debt ceilings and shutdowns don’t help, either.

Re the second question—why haven’t the forecasters self-corrected?—it is by definition the case that the models are inadequately capturing the factors above, including any I’ve left off. However, before you trash the forecasting endeavor in general, and you wouldn’t be far off to do so, consider that it’s awfully tricky to build Tea Party obstructionism into an economic model. Also, the impact of inequality on consumption growth is well-established theoretically, but less so empirically, in part due to the wealth effect noted above. Thus, there are complex interactions beyond the scope of current models.

End of the day, my advice is: don’t think of these point estimates as reliable predictions. Instead, think of them as a) what the Fed thinks, which has implications for monetary policy, and b) more importantly, as a clear message that if we want to get to and stay at full employment, we’ll need to reverse the negative practices listed above. That is, we’ll need better fiscal policy, investment in productive infrastructure, less inequality, and functional politics.

Gosh, when you put it that way, it doesn’t sound so hard, right?!

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12 comments in reply to "What’s up with the markdowns?"

  1. Guest says:

    Surprising you wouldn’t mention monetary policy (and lack of sufficiently supportive accommodation by the Fed) as a cause. They are talking about raising rates when they are consistently undershooting both inflation and GDP targets.

    • Jared Bernstein says:

      True, but they’ve largely held the monetary pedal to the metal thus far. Much better than the fiscal authorities!

  2. Peter K. says:

    Instead of bad fiscal policy, I would substitute bad macro policy which means a bad fiscal-monetary mix and an “uncompetitive” dollar.

    This is why I support a switch to an NGDP path level target or Josh Bivens’s nominal wage target. You could set up an NGDP futures market and bet on whether the economy will meet its potential (as devised by the CBO and other experts) or how much the Fed and macro policy will fail. It will be a blinking red light that the Fed and Congress aren’t doing their jobs.

    These past few years I would have bet against the Fed’s guestimate forecasts as they’ve been reliably too optimistic. For a year we were assured they would raise rates this month and I knew they wouldn’t.

  3. Wondering says:

    This is a great explanation. There’s not much I disagree with, except perhaps the point about political gridlock. I don’t think ending political gridlock in any way possible is a means to an end, so I can’t agree that it is always bad.

    If a political system is run in such a way as to do anything possible in the hope that it will avoid an economic downturn, then it is bound to make some horrific mistakes.

    I hear some rhetoric coming out that this is a world-wide problem to be solved by world-wide political solutions. That is wrong in my view. It is destructive to the US political system to view this as a world-wide political problem. It is a US political problem that needs to be addressed directly in the US. Unfortunately, we’re going to have to face this whether we temporarily defer to a larger agenda or not.

    We all want to see economic growth again, I think. But we don’t want to see democracy or populism trashed in favor of a higher GDP. Don’t do stupid stuff!

    We’re at a turning point. If we imagine that the problem is elsewhere, we can’t solve it. The problem is right here, and it is caused by the reigns of the political system being handed to investors. It won’t work anymore.

    The investors want purely private investments, and so they’re willing to look overseas to get what they want, and it won’t help the US out of its problem at all. In fact, it will exacerbate both our political problems and our economic problems.

    This is just my opinion, obviously. But I hold to it very strongly.

  4. Tammy says:

    Well, I reread the preface, introduction and Chapter 1 of the paperback edition of Paul Krugman’s book titled “End This Depression Now” today. What I’m most disappointed about is–understanding that the short and long term is equally important–that it has been 8 years (technically since the beginning of the Great Recession but I would argue it’s more than 8 years), effecting K-12th grade students. There’s been a lot of damage to this generation, and when I repeatedly hear it’s the parents fault I become agitated.

  5. Tammy says:

    I should have stated my comment wasn’t meant to pick on Ben Bernanke or yourself when serving on the Obama administration and work with the Congressional Budget Office.

  6. Fred Brack says:

    When you say, “(we) need better fiscal policy, investment in productive infrastructure, less inequality, and functional politics,” you’re just being unnecessarily opaque, Jared.

    Plainly put, what we need are fewer congressional Republicans.

    Until analysts and pundits begin speaking with such succinct clarity there’s no possibility we will get the sustained-growth policies we require to restore our economy to its full-employment potential. Speaking this fundamental truth over and over doesn’t guarantee fewer congressional Republicans will result. But not drumming the truth into voters’ consciousness guarantees Republican congressional control cannot possibly be threatened.

  7. Jill SH says:

    Bad fiscal policy and weak investment. Do you or the Fed take into account the abysmal record of many state governments?
    I just spent 5 days in mid-coast Maine away from my NH home, listening to public radio in two states, and being chagrined at the state of states’ finances. In Maine, a Tea Party governor did some 60+ line item vetoes ($2-3 million here, $30 million there, etc.) that the Democratic legislature is rapidly trying to reverse. In NH, I come home to a Democratic governor planning on vetoing a Republican budget that lowers the corporate tax rate 0.05% (losing $17million in revenue in 2017) while letting our Medicaid expansion sunset at the end of 2016 (cost to NH in 2017, $14 million; forgoing $350 million in federal funding), just to give you a sense of the legislature’s priorities.
    Put that in your GDP estimates and smoke it. (And I didn’t even mention what happened with the gas taxes.)

    • Jill SH says:

      Correction: the NH corp tax rate will come down .5% (half a percent) from 8.5 to 8. Yes, it is kinda high, and I do think it should come down, but where’s the offset? HEALTHCARE????

  8. Kevin Rica says:

    Dress them up anyway you like, but most fancy econometric models turn out to be overpriced, naive models (simple trend extrapolations). The models are simply forecasting that the the economy is going to return to the long-term historic rate of trend growth in a couple of years, barring any direct evidence to the contrary. Then, as we get closer to the actual date, direct evidence to the contrary becomes available and the models reflect that in the NEAR future the economy won’t return to trend.

    Now go back and look at the records of all these models and forecasting agencies. Ask yourself, “How often did they forecast any turning points or deviations from trend ahead of time?” The answer will be ” ‘pert near never!”

    But heck, if you believe in full employment, econometricians need to make a living too! Don’t break their rice bowl.

  9. Richard says:

    It ‘doesn’t sound so hard.’ Surely you must be joking! Just look at what Congress has done in the last few years…..it can’t/won’t do much of anything to resolve the dynamics described in this piece. Until it does, our economy will continue to limp along at less than full capacity/growth while the Tea Party and others complain that Obama/progressive ‘big government’ is the cause. It amazes me how they can continue to spout that mantra when all the facts suggest that it is THEY who are the problem. But the, don’t bother them with the facts!