Bernanke on the Fed’s new view of the economy

Ben Bernanke has a post discussing the Fed’s evolving view of the economy:

I’ll focus here on FOMC participants’ longer-run projections of three variables—output growth, the unemployment rate, and the policy interest rate (the federal funds rate)—and designate these longer-run values by y*, u*, and r*, respectively. Under the interpretation that these projections equal participants’ estimates of steady-state values, each of these variables is of fundamental importance for thinking about the behavior of the economy:

  • Projections of y* can be thought of as estimates of potential output growth, that is, the economy’s attainable rate of growth in the long run when resources are fully utilized

  • Projections of u* can be viewed as estimates of the “natural” rate of unemployment, the rate of unemployment that can be sustained in the long run without generating inflationary or deflationary pressures

  • Projections of r* can be interpreted as estimates of the “terminal” or “neutral” federal funds rate, the level of the funds rate consistent with stable, noninflationary growth in the longer term

He then explain how over the past few years the Fed has tended to consistently overestimate these variables:

Why are views shifting?  The changing views of FOMC participants (and of most outside economists) follow pretty directly from persistent errors in forecasting economic developments in recent years:As the table shows, FOMC participants have been shifting down their estimates of all three variables—y*, u*, and r*—for some years now.

Notice that there is no mention of the fact that the markets, and hence market monetarists, have generally been more accurate than the Fed.  We take financial market predictions seriously, and thus immediately discounted the Fed forecast of 4 rate increases in 2016, made back in December.  Indeed for years I’ve been arguing that the Fed’s dot plot is too optimistic about the Fed’s ability to raise interest rates under its current policy regime.

More than two years ago I suggested that 3% NGDP growth and 1.2% RGDP growth were the new normal, at a time when the Fed was still forecasting considerably higher rates.  Bernanke says the lower natural GDP growth rate is partly due to surprisingly low productivity growth.  Back in 2011, I suggested that we were having a “job-filled non-recovery“, just the opposite of the jobless recovery being discussed by many pundits.  Since then we’ve continued to have a job-filled non-recovery, with faster that expected job creation and a fast falling unemployment rate, accompanied by slower than expected RGDP growth.  This is just another way of saying that productivity growth has been lousy (indeed negative for three quarters in a row.)

It’s nice that the Fed is finally seeing the light on issues that market monetarists have been emphasizing for many years.  But I’d feel better if they took this as a lesson that they need to change their entire operating system, and start relying much more on market forecasts.

Back in 1997, Bernanke published a paper with Michael Woodford (in the JMCB) suggesting that market forecasts could be useful to policymakers, if they revealed information about the impact of different monetary policy instrument settings.  OK, so why doesn’t the Fed take Bernanke’s advice and create a set of prediction markets for inflation and output, one for each plausible instrument setting.

PS.  By “job-filled non-recovery” I did not mean that we were not getting closer to the natural rate, I meant we are not recovering in the sense of going back to the old trend line.  Clearly the labor market has been gradually recovering.

HT:  Bill Beach, Patrick Horan




28 Responses to “Bernanke on the Fed’s new view of the economy”

  1. Gravatar of Gabe Gabe
    9. August 2016 at 07:20

    “OK, so why doesn’t the Fed take Bernanke’s advice and create a set of prediction markets for inflation and output, one for each plausible instrument setting.”

    This is why I keep coming here Dr Sumner. You see the contradictions. You are one of the few who aren’t willing to just pretend they don’t exist. I am just curious how this will finally be resolved for you. “The Fed” or whoever has ultimate decision making power there…does not really have a first priority that they publicly declare…..the publicly declared priorities are window dressing, they are arguments to help them get the power to do what they do…and they don’t really have to tell us what they really do.

  2. Gravatar of Gary Anderson Gary Anderson
    9. August 2016 at 08:10

    The Fed only cares about demand for sovereign bonds. As long as they keep their value, the elite who they work for stay wealthy beyond what is imaginable.

  3. Gravatar of Benjamin Cole Benjamin Cole
    9. August 2016 at 08:29

    The Fed and the continual harping for tighter money is a strange mystery.

    Vulgar Marxist perspective is pretty good at deciphering macroeconomic policy posturing, even if Marxism is a terrible prescription.

    But the Fed and right wing’s fixation with inflation appears to spill over into something that sociopathologists need to examine.

  4. Gravatar of Gabe Gabe
    9. August 2016 at 08:43

    Gary Anderson, if wealth is all they care about…why not go short and long the bonds at various times?

  5. Gravatar of ssumner ssumner
    9. August 2016 at 10:18

    Gabe, I see many factors here. I don’t think the Fed necessarily did what Bernanke wanted it to do, even when he was Fed chair. And I’m not at all sure he favors the creation of prediction markets, he simply indicated that conditional forecasts of things like inflation could be useful if they provided information about which instrument settings were most likely to hit the target. But that’s a long way from actually favoring that the Fed create such markets.

  6. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    9. August 2016 at 10:41

    Remember the old joke that Paul Krugman had been kidnapped and his NYT columns were being written by an imposter? I think the kidnappers have struck again.

    I say we pay the ransom and get Ben back.

  7. Gravatar of Gabe Gabe
    9. August 2016 at 10:54

    “I see many factors here. I don’t think the Fed necessarily did what Bernanke wanted it to do, even when he was Fed chair.”

    agreed Scott, Fed chair is a showman/puppet/scapegoat….just like the president. It is often times useful for them to actually believe what they are saying, but they all know they have to answer to certain real power brokers or end up like JFK.

  8. Gravatar of Randomize Randomize
    9. August 2016 at 11:25

    The low increases in productivity seem natural given the demographics of the unemployed; highly-educated workers are fully employed and workers without any post-high school education make up the bulk of the unemployed. Because GDP equals GDI, and only workers who are likely to receive low incomes are the ones who are still being put back to work (the high income workers already have jobs), the increases in GDI from the falling unemployment rate are expectedly low.

    Because of the above, the only way we’ll see big productivity gains (and thus big RGDP gains) is through supply side improvements.

  9. Gravatar of bill bill
    9. August 2016 at 12:57

    “Seeing the light” is quite charitable. How long do you think it will be until the Fed Funds rate is 3%?

  10. Gravatar of Major.Freedom Major.Freedom
    9. August 2016 at 15:46

    “Notice that there is no mention of the fact that the markets, and hence market monetarists, have generally been more accurate than the Fed. ”

    That is a non sequitur. Market monetarists are not logically posteriori to markets. The name doesn’t fool any reasonable person.

    A market in money would mean, you know, an actual market in money. You cannot have a market in money with a socialist monetary system.

    Just because some monetarists want the central bank to target a different variable than they are now, that does’t make them “market” monetarists. There are people not in the government forecasting price levels (CPI, etc), but that doesn’t make them “market” forecasters.

    The people in the Fed who forecast future variables are using the same general models as those not in the Fed who forecast those future variables. Siding with one group or the other doesn’t make one a truster of markets over not markets. There is no market.

  11. Gravatar of Gary Anderson Gary Anderson
    9. August 2016 at 17:14

    @Gabe I think it would not be farfetched for the Fed’s playmates to short long bonds during tantrums. They can feel confident that demand won’t go away. So, who knows? This constant tantrum talk is so ridiculous. It never keeps sovereign bond yields up for long.

    I have an opinion, based on research of others, and based on common sense as we see bonds relentlessly creep toward zero all along the curve, that bond demand is massive, and the Fed will nurture that demand.

    This is why Benjamin Cole’s statement is a sarcastic expression of the truth:

    “But the Fed and right wing’s fixation with inflation appears to spill over into something that sociopathologists need to examine.”

    It makes no sense to have a fixation with inflation unless you are throwing a tantrum.

  12. Gravatar of Anand Anand
    9. August 2016 at 20:30

    Slightly off-topic: Paul Krugman’s new post ( is interesting. Is he rethinking his view of monetary policy?

    He starts off by saying that the ZLB was not quite a ZLB. Then he says that US and Japan are close to full employment and thus the supply side comes into play. Then he says that we can’t assume that Fed won’t indulge in monetary offset now. So far, he almost sounds like Scott Sumner.

    But then he says that we should be conducting policy as if the ZLB still applies. That is a head scratcher.

    Perhaps Krugman is unwilling to let go of the hammer even though the problem no longer looks like a nail. I think he might come around, given a bit more time.

  13. Gravatar of Saturos Saturos
    9. August 2016 at 22:29

    Glenn Stevens is very Keynesian, begging for deficit spending:

    Meanwhile NAB economists predict Australian QE:

  14. Gravatar of Benjamin Cole Benjamin Cole
    10. August 2016 at 02:07

    New Zealand home prices prompt calls for immigration cut
    WELLINGTON — Soaring house prices in Auckland, New Zealand’s largest city, are prompting growing calls for cuts in immigration, which is running at record levels.It is not only politicians and commentators that are talking about cutting the number o…


    New Zealand joins Australia and Canada…

  15. Gravatar of Chuck Biscuits Chuck Biscuits
    10. August 2016 at 03:58


    Not a Krugman fan by any means, but I read that article as him simply adjusting his viewpoint in light of the situation. This kind of sensible approach is suspect to market monetarists?

  16. Gravatar of Benny Lava Benny Lava
    10. August 2016 at 05:02

    Scott, was it you or was it Tyler that observed such a situation in Britain a few years ago; declining productivity and falling unemployment? Someone at the time thought it was because GDP was risining because of the growth of the financial service industry and at the same time unemployed people were falling off the labor market entirely.

  17. Gravatar of Gary Anderson Gary Anderson
    10. August 2016 at 05:28

    This is what happened in the old days when people hoarded bonds. It was a precursor to the massive demand for bonds in our time: In 1991, US Treasury Deputy Assistant Secretary Mike Basham learned that Salomon trader Paul Mozer had been submitting false bids in an attempt to purchase more treasury bonds than permitted by one buyer during the period between December 1990 and May 1991. Salomon was fined $290 million for this infraction, the largest fine ever levied on an investment bank at the time. The firm was weakened by the scandal, which led to its acquisition by Travelers Group. CEO Gutfreund left the company in August 1991 and a U.S. Securities and Exchange Commission (SEC) settlement resulted in a fine of $100,000 and his being barred from serving as a chief executive of a brokerage firm.[10] The scandal was then documented in the 1993 book Nightmare on Wall Street.

    The link to the article showing that the history of structured finance is really what the growth of the financial industry is all about is at my name, Benny.

  18. Gravatar of Ray Lopez Ray Lopez
    10. August 2016 at 05:32

    Aside from the overall good points made by MF, another observation is that “output growth, the unemployment rate, and the policy interest rate” are actually just one independent variable (output growth) and two dependent variables: the unemployment rate (no Virginia, there’s no such thing as a ‘natural’ unemployment rate that’s steady, it jumps around and is akin to simply saying in any population there are able bodied people who don’t care to work, a trivial observation), and, the second dependent variable is “the policy interest rate” which is not in fact set by ‘policy’ but rather by the market (money is neutral; Fed has no long term ability to set rates), and in turn the market for interest is determined by the independent variable, output growth.

    Longer story by Bernanke shorter: the output growth rate is random in an economy, with an upward historical bias, and the other variables dependent on this growth rate. We at the Fed pretend we can set interest rates, and pretend that NAIRU exists as a constant and we have control over it. Suckers like Scott Sumner believe in our bogus magic.

  19. Gravatar of Gary Anderson Gary Anderson
    10. August 2016 at 05:36

    And in the same article, I quote Alan Greenspan who said this in 2005:

    “…the sophisticated risk-management approaches that derivatives have facilitated are being employed more widely and systematically in the banking and financial services industries… Of particular importance is the management of counterparty credit risks. Risk transfer through derivatives is effective only if the parties to whom risk is transferred can perform their contractual obligations. These parties include both derivatives dealers that act as intermediaries in these markets and hedge funds and other nonbank financial entities that increasingly are the ultimate bearers of risk.”

    So, Greenspan was obsessed with moving risk off the banks onto nonbank financial entities that increasingly are the ultimate bearers of risk. And of course, the Asset Backed Securities didn’t do so well, so counterparties flooded into sovereign bonds as the safer collateral. If they were going to bear more risk, they needed to have safer collateral. But this demand for bonds started at the beginning of structured finance, and the bigger structured finance got, the more sovereign bonds became important.

    Greenspan’s entire reign was all about putting off risk to the banks and onto counterparties, as he had worked in the S&L industry prior to being named Chairman of the Fed.

    With the scandal of AIG there arose clearing houses for collateral, and they hold an ever greater amount of the risk in the financial system.

  20. Gravatar of ssumner ssumner
    10. August 2016 at 05:56

    Bill, Don’t know, I probably won’t be around by then.

    Thanks Anand, that’s interesting.

    Saturos, That’s pretty sad, especially for a central bank not at the zero bound.

    Benny, Yes it was me, but I offered the opposite explanation—declining financial services and growth of low skilled jobs.

    Ray, You are getting boring again. I like wacky stupid more than boring stupid.

    And you’ve never heard of Gerhard Richter?

  21. Gravatar of Anand Anand
    10. August 2016 at 08:19

    @Chuck Biscuits,
    If I gave the impression that Krugman is doing something suspect, I didn’t mean to. I am simply observing how his views are evolving in a market monetarist direction, but he is still unwilling to abandon the approach he advocated a few years earlier even though we are no longer at ZLB.

    By the way, I am not knowledgeable enough to second-guess Krugman, nor are my monetary views fixed. I am a long-time read of Krugman, way before I was ever aware of this blog. I was originally completely convinced by his idea of monetary theory.

    What I know is this: Krugman is extremely smart. If his views are indeed evolving towards a market monetarist direction, perhaps there is a certain amount of truth to that model.

  22. Gravatar of Ray Lopez Ray Lopez
    10. August 2016 at 16:29

    Sumner to Ray: “And you’ve never heard of Gerhard Richter” ??? that was from my reply to Tyler Cowen’s blog; don’t you know cross-posting is bad manners? No manners indeed, since you call your regular readers morons.

    As I said, not only do I know of Richter, I’ve seen his works in the original in the Hess art museum in Napa valley. By contrast, have you ever seen money illusion, Mr. Delusion of Monetarism?

  23. Gravatar of Brian Donohue Brian Donohue
    11. August 2016 at 04:52

    Great post, Scott. Keep on truckin’!

  24. Gravatar of ssumner ssumner
    11. August 2016 at 06:10

    Ray, You said:

    “By contrast, have you ever seen money illusion”

    Every time I read your comments.

    Thanks Brian.

  25. Gravatar of Benny Lava Benny Lava
    12. August 2016 at 10:15


    Do you think the situation is the same? Declining financial services and increasing low wage service jobs (maybe Yglesias’ mythical yoga instructors?).

  26. Gravatar of ssumner ssumner
    12. August 2016 at 11:49

    Benny, My hunch is that both types of jobs are increasing, but I haven’t studied the issue closely.

  27. Gravatar of Steve Steve
    14. August 2016 at 16:25

    Professor Sumner,
    I am sorry if this sounds like a stupid question, I am just trying to understand this more.
    1) If low productivity growth is the problem i.e. we produce less widgets per unit of labor/capital, shouldn’t we ultimately start to see inflation emerge?
    2) There already is a market for ‘inflation compensation’ i.e. the Breakeven Inflation market (swaps and linkers). Currently 5y5y Breakeven inflation in the US is c.2% and is only 0.25% in Japan. What do you prescribe to be the necessary course of action for a central bank such as the BOJ in raising inflation expectations?

  28. Gravatar of Scott Sumner Scott Sumner
    14. August 2016 at 19:49

    Steve, Whether you’d expect inflation depends on what the rate of NGDP growth is. If low, you might not get inflation, even with slow productivity growth.

    To raise inflation expectations, the easiest method would be level targeting. Then cutting interest rates to zero. More difficult methods include QE and negative interest on reserves.

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