Few critics would accuse Federal Reserve officials of being Pollyannas. If their recent economic growth forecasts are any indication, though, such a sobriquet would be fitting. In four of the past five years, the growth predictions of Federal Open Market Committee (FOMC) members each December and January overshot the actual gross domestic product expansion of the following 12 months (see chart 1).
| Year | Fed GDP Growth Forecast from January of the Same Year or December of the Prior Year | Actual Growth |
| 2010 | 3.2 percent | 2.7 percent |
| 2011 | 3.7 percent | 1.7 percent |
| 2012 | 2.5 percent | 1.6 percent |
| 2013 | 2.7 percent | 3.1 percent |
| 2014 | 2.9 percent | 2.4 percent |
| *Measured as the midpoint of the central tendencies forecast by FOMC members. | ||
The Fed’s forecasts stem in part from peculiar economic factors of the past few years, in part from the inherent difficulty of predicting economic growth and in part from institutional imperatives among monetary policymakers. “Things happened that the Fed didn’t anticipate,” says Donald Kohn, a former Fed vice chair, now a senior fellow at the Brookings Institution in Washington. Others agree.
After the economy began its recovery from the 2008–’09 financial crisis, “the Fed underestimated the economic consequences of massive deleveraging, especially household balance sheets and investment,” says David Stockton, senior fellow at the Peterson Institute for International Economics in Washington and a former top economist at the Fed. “Just when that was beginning to wear off, there was a failure to predict just how big a swing there would be in fiscal policy from 2011 to 2013,” he continues. Congress implemented massive budget cuts during those years, and taxes were increased in 2013. The fiscal tightening took as much as 1 percentage point a year off GDP in 2012 and 2013, Stockton notes.
Then there is the European debt crisis that has reared its head periodically over the past five years. That has hurt the U.S. economy by curbing European demand for imports and sparking global financial turmoil. Finally, “the supply side has underperformed the expectations of the Fed and others,” Stockton notes. “There has not been much productivity growth at all.” To be sure, some question whether the productivity numbers are accurate.
But, argues Alex Pollock, former president and CEO of the Federal Home Loan Bank of Chicago and now a resident fellow at the American Enterprise Institute in Washington, perhaps “everybody’s economic forecasts are bad. The Fed is no different from everyone else.” Given the complexity of the global macroeconomic outlook and that, as Pollock puts it, “it’s made up of human beings reacting to each other,” the economy’s future is inherently unknowable.
| Years | Blue-Chip Economic Indicators Consensus Forecast from January of Same Year | Actual Growth |
| 2010 | 2.9 percent | 2.7 percent |
| 2011 | 3.3 percent | 1.7 percent |
| 2012 | 2.3 percent | 1.6 percent |
| 2013 | 2.2 percent | 3.1 percent |
| 2014 | 2.8 percent | 2.4 percent |
The Fed’s forecasts were off by a total of 4.3 percentage points from 2010 to 2014 (see chart 2), while the 50-plus economists surveyed by the newsletter Blue Chip Economic Indicators missed by a total of 3.8 percentage points. The Fed’s forecasts surpassed actual growth by a total of 3.5 percentage points, compared with 2 percentage points for the Blue Chip economists.
So, as Pollock asks, “why isn’t it symmetrical” between Fed officials and private economists? That’s where a little institutional bias creeps in, he says. “The Fed wants to build people’s confidence, so there’s a natural bias toward overoptimism. It’s afraid that pessimistic announcements will be self-fulfilling.” Moreover, it’s the Fed’s job to help keep the economy healthy. FOMC members are instructed to make their economic projections with the assumption that appropriate monetary policy will be pursued. “They tend to predict a reasonably good outcome for the long run, thinking they can make the policy to make that happen,” Kohn says.
To be sure, Stockton notes, in the 1990s, when the economy was going gangbusters, the Fed underestimated economic growth. Of course, an argument can be made that in one sense these forecasts were overly optimistic because a slower growth path generally means low inflation, which is part of the Fed’s mandate.
“There’s a certain social psychology to being an official at the Fed,” Pollock says. “If you’re part of the Fed, you’ve been selected as someone who can control the future. Otherwise, why be there?”
If you have that belief, “you would naturally be optimistic,” he says.
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