A low volume, high quality source from the demand side perspective.The podcast is produced weekly. A transcript is posted on the day of.

Thursday, March 5, 2009

Fed Forecasts in the Dark

Demand Side's forecasts have beaten the consensus and the blue chips and would have placed in the top five of the Wall Street Journal's competition. The weight assigned to interest rates and the collapse of inflation with the collapse of the financial sector kept us down.

Fed Forecasts in the Dark

More remarkable, however, than our success is the failure of the Federal Reserve's open market committee. Upon ascending to the post of Chairman of the Federal Reserve Board, one of Ben Bernanke's first initiatives was to institute the publication of forecasts of the Fed's open market committee. It was and still is a thinly disguised inflation targeting exercise. But it has proven to be more an exercise in embarrassment, as the bankers repeatedly and consistently miss and miss widely not only inflation, but GDP and employment numbers. It is as amusing as a chart can be to see the latest quarter's numbers have migrated out entirely from under the dotted lines that mark the previous quarter's estimates.

To be fair this has not occurred in January's GDP for 2009, but only because there are twelve months of 2009 left. A more representative example would be the October figures. With only three months left in 2008, the esteemed economists were still radically downsizing their estimates. It is our observation that the markets are no longer leading indicators of economic events, but coincident. The Fed's estimates of the economy are no longer coincident, but lagging.

FOMC unemployment estimates for 2009 jumped a point and a half in the three months between its October and January meetings, with the minimum expected now at 8.0. Inflation projections are dropping, we suspect, from the evidence of no inflation, rather than from any inference regarding the commodities bubble or financial system crash.

The bottom line is that they have no idea. The Fed expected their monetary policy moves to do something and they have not. At this hour Battling Ben is applying bandages to wounds that need a tournequet and splint. It is a big part of our prediction of a snap back in late 2009 that the situation will get so bad there will be no room for these alternatives to the proper treatments.

On inflation, the Fed has no clue about cost-push inflation and so missed entirely the effects of the commodity bubble on prices. On growth, they have been laggards in realizing the severity of the housing collapse, but most troubling, they have been unable to comprehend the financial sector collapse. This began in August 2007. We arrive in March 2009 with the markets experiencing another jump condition, the financial firms requiring ever more transfusions, and the Fed's and Treasury's remedies having little more effect than waving their arms.

It is not necessary to accept the Demand Side prescriptions to see that the orthodox remedies have not worked, are not working and by extension will not work no matter how many times they are applied. Initially, in the fall of 2007, the markets were confident the Fed could ride to the rescue and were encouraged by every rate cut and new liquidity mechanism. Not only has there been no rescue, there has been no slowing of the train.

Fed Policy a Loser

The monetary policy excursions were defeated time and time again. Bear Stearns, Lehman Brothers, IndyMac, AIG .... you can mark the collapse from any one of these events, but that misses the clearly systemic nature of the collapse. The Fed is responsible for keeping the banking system stable. It has not only failed, it has failed spectacularly. Yet it shows little willingness to alter course. And there is woefully little demand that it do better.

A year ago it was Captain Ben to the rescue. Today it is a tired and defeated Dr. Bernanke who knows nothing more to do than push more borrowed chips into the center of the table and hope for a better hand on the next draw.

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