Guest Post: The Fed And Goldilocks Economic Forecasting

Tyler Durden's picture

Submitted by Lance Roberts of StreetTalk Advisors

The Fed And Goldilocks Economic Forecasting

fed-revisions-gdptable-062112Beginning in 2011 the Federal Reserve begin releasing its economic forecast for the present year and two years forward covering GDP, Unemployment, and Inflation.  The question is after 18 months of forecasting - just how good has the Fed at forecasting these economic variables?  I have compiled the data from each of the releases for each category and compared it to the real figures and used a current trend analysis for future estimates.


When it comes to the economy the Fed has consistently overstated economic strength.   Take a look at the chart and table.  In January of 2011 the Fed was predicting GDP growth for 2011 at 3.7%.  Actual real GDP (inflation adjusted) was 1.6% or a negative 56% difference. The estimate at that time for 2012 was almost 4% versus 1.8% currently.

We have been stating repeatedly over the last 2 years that we are in for a low growth economy due to the debt deleveraging, deficits and continued fiscal and monetary policies that are retardants for economic prosperity.  The simple fact is that when an economy requires nearly $5 of debt to provide $1 of economic growth the engine of prosperity is broken.

fed-revisions-gdptrend-062112As of the latest Fed meeting the forecast for 2013 and 2014 economic growth has been revised down as the realization of a slow-growth economy has been recognized.  However, the current annualized trend of GDP suggests growth rates in the next two years that will roughly be half of the Fed's current estimates of 2.85 and 3.4%.  A recession in 2013 is a strong likelihood given the current annualized trend of economic growth since 2000.   A recession followed by a rebound in 2014 would leave economic growth running at annual rate close to 1%-1.5% versus the current estimate of nearly 3%.

What is very important is the long run outlook of 2.6% economic growth.  That rate of growth is very sub-par and, over the longer term, does not sustain the level of incomes and employment that were enjoyed in previous decades.


The Fed is as overly optimistic about the level of unemployment as they are about economic growth. One of the Fed's mandates is "full employment." At the beginning of 2011 the Fed predicted the unemployment rate for the year would be 8.7% for 2011, 7.8% for 2012 and 6.95% for 2013.  The unemployment rate for 2011 was 9.1% and is currently at 8.2% currently likely to rise in the coming reports ahead as the economy again weakens.

fed-revisions-unemploytable-062112The Fed sees 2014 unemployment falling to 7% and ultimately returning to a 5.6% "full employment" rate in the long run.  The issue with this full employment prediction really becomes what the definition of reality is. 

Today, even the average American has begun to question the credibility of the BLS employment reports.  Recently even Congress has launched an inquiry into the data collection and analysis methods used to determine employment reports.  Since the end of the last recession employment has improved modestly but mostly centered around temporary and lower paying positions. 

Since mid-2011 there has been a fairly sharp decline in the unemployment rate from 9.1% to 8.2% currently.  The main driver of that decline has come from a shrinkage of the labor pool versus substantial increases in employment.  In our past employment reports we have discussed the increasing number of individuals that are moving into the "Not In Labor Force" category where they are no longer counted as part of the labor pool.  For the Fed the reality of "full employment" and statistical "full employment" are two entirely different things.   While the Fed could be very correct at achieving "full employment" of 5.6% in their longer run scenario - it certainly doesn't mean that 94.4% of working age Americans will be gainfully employed.


When it comes to inflation the Fed's outlook, for the most part, have been below reality.  In January of 2011 The Fed's prediction for 2011 inflation was 1.5% which was 2% lower than what inflation turned out to be. 

As of the latest meeting the Fed's 2012 inflation prediction is 1.6%.  With current deflationary pressures pulling headline inflation down from 3% at the beginning of this year to 1.7% currently the Fed's prediction appears to be fairly accurate.  The question, however, is how long can inflation remain suppressed at or below 2% which is the long run prediction of the Fed? 

The Fed has much more control over inflationary pressures in the economy than they do at stimulating economic growth or increasing employment.  By increasing or decreasing interest rates, using monetary policy tools and coordinated actions the Fed has historically been able to influence inflation.  Unfortunately, their actions in this regard can also be directly linked to economic and market booms and busts. 

fed-policyactions-crisis-062212What the Fed has much less control over are deflationary pressures.  We have discussed that the threat of deflation in the U.S. economy is currently a much greater than inflation.  It is also the primary concern of the Fed.  However, there are two things that are likely occur that could drive headline inflation higher than the Fed's current long run estimate of 2%.  The first is further stimulative action which expands the Fed's balance sheet known as "quantitative easing."  The direct impact of these programs, as liquidity is injected into the financial system, has been higher commodity prices which translates to an increase in headline inflation. 

The second, and more importantly, is that an organic economic recovery will eventually take hold.  During real economic expansions where demand is increasing, wages are rising and the velocity of money is accelerating - real levels of higher inflation take hold.  However, an organic economic expansion is likely some years away as the balance sheet deleveraging cycle continues globally.

Why The Fed Forecasts Like Goldilocks

Is the Federal Reserve really as bad at predicting future economic conditions as it appears?  The answer is no.  The Federal Reserve faces a severe challenge, when communicating to the financial markets and the media, which is the creation of a self-fulfilling prophecy.  Imagine that following an FOMC meeting Bernanke stated:  "The policies and actions that we have implemented to date have done little to curb economic weakness.  The economy is in much worse shape that we have previously communicated as the transmission system of Fed policy through the economy, and the financial markets, is obviously broken."

The immediate reaction to such a statement would be a complete collapse of the financial markets.  Such a collapse in the financial markets would negatively impact consumer confidence which would subsequently throw the economy into a recession.  Conversely, an overly optimistic outlook would lead to an increase of inflationary pressures and asset bubbles.  Neither situation is healthy for the economy in the longer term.  Therefore, communication from the Federal Reserve must be very guided in its approach - not too hot or cold.  This "goldilocks"  appoach works to create a "glide path" to the Fed's destination while giving the financial markets and economy time to adjust to the incremental adjustments to forecasts.

Let me be clear.  I am not making a case for the relevance of the Federal Reserve or its policies.  That is another article entirely.  What I am stating is that the communications from the Federal Reserve should NEVER be taken at face value.  Since the Fed can not communicate its real position at any given time, due to the immediately excessive postive or negative effect on the economy and financial markets, as investors we must read between the lines.  The problem for the financial markets, and the mainstream media, is that they tend to extrapolate current estimates indefinitely and generally in an upwardly biased manner.  This is not the Fed's objective nor have they been able to repeal the economic and business cycles.

The Fed has been slowly guiding economic forecasts lower since 2011.  The reality is that 2.6% economic growth is not a boon of economic prosperity, corporate profitability, increasing incomes or a secular bull market.  It is also not the "death of America" or the return to the stone age.  What is important to understand, as investors, is the impact on investment portfolios, expectated real rates of returns and the realization that higher levels of market volatility with more frequent "booms and busts" are here to stay.

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
francis_sawyer's picture

Anyone can change the GDP "FORMULA" at anytime to make it what they want... It's a formula that only 'tools' like Krugman can get attracted to (like bugs to a bug zapper)...

financial apocalyptic contagion's picture

nothing new

the Fed is a compulsive lier

ArkansasAngie's picture

Oh Joy!!!!

Certainty.  Finally.

Too bad I don't feel any better

Going to rush right out and buy the building across the street at its 2007 price ... NOT


Stackers's picture

Well at least they are getting the current year's "projection" correct in the last quarter of the year.......still waiting on the magic burst up to 3.5% though, hmmmm

MuppetMaster's picture

I have found Alpha. & I give it to you for free.

Come see what I'm doing. See what I'm seeing.

mayhem_korner's picture



this GDP growth is too hot...this GDP growth is too cold...but this GDP growth is just right

yours, Ben

Bastiat's picture

Posted this in another thread but thought it worth repeating:

Moody's shoots down bank-backed Muni Turkeys.

My guess is that these muni bonds are floating rate bonds with direct-pay bank letters of credit.  LOC bank downgrades have interesting effects.   The muni exposure could also be coming from exposure to bank as interest rate swap counter-parties.  Unlike the case with a downgrade of a "sell and forget" fixed rate bond, these floaters get nasty--for instance: how do you replace the LOC when there are fewer and fewer banks with suffcient ratings (or appetite). When swaps counter parties go under it is often the ISSUER's responsibility to replace the failed counter party, or the issuer must post collateral to defray the risk to the other part of swap.  There will be blood.

mayhem_korner's picture



Forecasting serves no purpose other than to provide an arbitrary buttress for some other decision.

Lednbrass's picture

The Goldilocks reference also works due to their fondness for encouraging the eating of somebody elses porridge.

Except here Goldilocks has a really looooong spoon, and you have your bowl over there, and she reaches over and eats your porridge!

Or just dumps it on the floor where the rats can get it, Im not really sure but it certainly isnt in the bowl of the bears anymore.

fonzannoon's picture

Anyone who believes the markets and the economy have anything to do with each other are completely deluded.

boiltherich's picture

The GDP growth figures are horseshit, they use a deflator that reduces growth by next to nothing because as we all know there is NO inflation in the economy.  Unless you eat, drive, carry insurance, go to a movie, play sports, go camping, buy tires, or rent.  A deflator that reduces GDP by a reasonable amout allowing for real inflation would be negative, not just negative but by more than they show as positive.

disabledvet's picture

So do they suffocate us with debt and kill inflation that way or just go the "good old fashioned hard money in the keister" route?

tony bonn's picture

"....The Fed has been slowly guiding economic forecasts lower since 2011. The reality is that 2.6% economic growth is not a boon of economic prosperity, corporate profitability, ..."

corporate profitability is divorced from local markets which is why it matters not a whit how the american economy is doing - that is the charm of globalization.....

corporate profits have been ample and profuse in spite of anemic to depressionary domestic economic conditions.....

ArkansasAngie's picture

Yup ... Government transfer payments at work.

Geez ... A heck of a job ... saved again.

TGIF ... or I might actually start saying what I think about all this crap

CrashisOptimistic's picture

"We have been stating repeatedly over the last 2 years that we are in for a low growth economy due to the debt deleveraging, deficits and continued fiscal and monetary policies that are retardants for economic prosperity."

Let me fix that.

. . . that we are in for a low growth economy because of relentless, inexorable oil scarcity that spikes its price any time there is an attempt at actual GDP growth, crushing that growth back to nothingness.  It won't get any better.



InconvenientCounterParty's picture

Take out Gov't transfer payments, imperialistic financial activity and killing machines what do you have left?

The concept of productivity needs to be re-introduced to the western world before parasites devour everything.


slewie the pi-rat's picture

slewie can practically feel the checks clearing tho

the FED is learning to like deflation, imo

deflation is the deus ex machina thus spake slewie

enjoy the day and don't forget:  everything sucks!  L0L!!!



ejmoosa's picture

The single best indicator of future job growth is the current year over year corporate profit growth.  The correlation is .91.

For jobs to be added during the following 12 months, year over year profits need to rise by more than 7-8%.

We are currenly below that threshold, and have been so for the last two quarters.

And that correlation has been growing stronger over the last thirty years.  

That level of correlation suggest that 81% of the hiring today is directly tied to the rate of profit growth.

Profit growth is something you will not hear mentioned by Obama or Bernanke.

And no, record profits for a few quarters is not the same as annualized, consistent profit growth, which is something the private sector needs to plan and grow effectively.



alfred b.'s picture


     EJ should downgrade the fed, even if it's only for being self-serving and incompetent!



PAWNMAN's picture



q99x2's picture

Goldilocks. That Bitch.

lamont cranston's picture

Goldilocks was a welfare queen. She's unemployed, wandering around the woods looking for a handout. B&E at the Bears' house. Destroys their private property and eats their food without so much as a thank you. Bitchy about its quality, even though its free. She deserves 3-5 at Parchman chopping cotton. 

Racer's picture

Gordon Brown:I see  "an end to boom and bust"

and sold a massive amount of  UK's gold at the lows...

Gold soared and bust was the bigger than the Great Depression and we are now in the GREATER Depression

Politicians and banksters are only in it for their own personal gain... FULL STOP

localpacific's picture

one thing is for certain this weekend we know how the futures will look: Treasury futures under pressure       

cooperbry's picture

I suppose there is something to be said for consistency.  They're consistently wrong.