Tuesday, July 5, 2016

If, if, and if

At Reddit: St. Louis Fed President, Jim Bullard, outlines new characterization of the outlook for the U.S. economy which criticizes forecasting more than 2.5 years into the future.

At the St. Louis Fed: The St. Louis Fed's New Characterization of the Outlook for the U.S. Economy by James Bullard, Cletus Coughlin, Bill Dupor, Riccardo DiCecio, Kevin Kliesen, Michael Owyang, Mike McCracken, Chris Waller, Dave Wheelock, and Steve Williamson.

From the blurb:

President James Bullard and his co-authors explain the St. Louis Fed’s new characterization of the U.S. macroeconomic and monetary policy outlook, which more explicitly takes into account uncertainty about possible medium- and longer-run outcomes.


The new approach is based on the idea that the economy may visit a set of possible regimes instead of converging to a single, long-run steady state.

Uncertainty about the future. Specifically: Perhaps "converging to a single, long-run steady state" refers to things like ... I don't have an example from the St. Louis Fed, but

CBO uses potential output to set the level of real GDP in its medium-term (10-year) projections. In doing so, CBO assumes that any gap between actual GDP and potential GDP that remains at the end of the short-term (two-year) forecast will close during the following eight years

the "single, long-run steady state" being the path of RGDP ten years out. Bullard says no more of this! Bully for you, Bullard!

As such, the new approach does not include projections for long-run values for U.S. macroeconomic variables or for the policy rate.

See? Less certainty.

Oh, heck, I really like this. Here's the whole blurb:

The PDF is The St. Louis Fed’s New Characterization of the Outlook for the U.S. Economy, nine pages.

From the PDF:
An older narrative that the Bank has been using since the financial crisis ended has now likely outlived its usefulness, and so it is being replaced by a new narrative. The hallmark of the new narrative is to think of medium- and longer-term macroeconomic outcomes in terms of regimes. The concept of a single, long-run steady state to which the economy is converging is abandoned, and is replaced by a set of possible regimes that the economy may visit. Regimes are generally viewed as persistent, and optimal monetary policy is viewed as regime dependent. Switches between regimes are viewed as not forecastable.

I just really like this. It is an admission they know less than they thought.

Under the heading WHY NOW in the PDF:
It is a good time to consider a regime-based conception of medium- and longer-term macroeconomic outcomes. Key macroeconomic variables including real output growth, the unemployment rate, and inflation appear to be at or near values that are likely to persist over the forecast horizon. Any further cyclical adjustment going forward is likely to be relatively minor. We therefore think of the current values for real output growth, the unemployment rate, and inflation as being close to the mean outcome of the “current regime.”

Of course, the situation can and will change in the future, but exactly how is difficult to predict. Therefore, the best that we can do today is to forecast that the current regime will persist and set policy appropriately for this regime.

Now is the time, they say, because inflation, unemployment, and real growth are "at or near values that are likely to persist" for the next two and a half years. This is interesting to me because they're not predicting recession within the next 30 months, and also because they and I disagree on the persistence of those current values. I expect growth to become vigorous within that time frame and unemployment to fall further, with inflation pressures reduced by the fall in the debt-per-dollar ratio since 2008. I've predicted vigor here and considered comparable vigors here.

The part about "the best that we can do" is straight out of Keynes:

In practice we have tacitly agreed, as a rule, to fall back on what is, in truth, a convention. The essence of this convention — though it does not, of course, work out quite so simply — lies in assuming that the existing state of affairs will continue indefinitely, except in so far as we have specific reasons to expect a change.

Continuing a thought in the WHY NOW section of the PDF:
If there is a switch to a new regime in the future, then that will likely affect all variables — including the policy rate — but such a switch is not forecastable.

It's not my area but this sounds to me very much like the uncertainty and ergodicity of which Syll writes so often.


Notes on Productivity:
We do not think of the current regime as “pessimistic.” Output grows at the trend pace of two percent, but the unemployment rate remains quite low, and inflation remains at two percent. In addition, as we will describe below, output growth could improve if productivity growth improves.

The new narrative views medium- and longer-term macroeconomic outcomes in terms of a set of possible regimes that the economy may visit instead of a single, unique steady state. By doing this, we are backing off the idea that we have dogmatic certainty about where the U.S. economy is headed in the medium and longer run. We are trying to replace that certainty with a manageable expression of the uncertainty surrounding medium- and longer-run outcomes.

The productivity growth rate has been low on average at least since 2011. We think of this as a low productivity growth regime. We know from past observation of the U.S. economy that productivity could switch to a higher growth regime. If such a switch occurred, it might have important effects on many variables, but especially on output growth, which would be higher.

If productivity growth improves. If such a switch occurs. I'm thinking they have no story about what drives productivity. I have a story about what drives productivity.


Other loose ends
We have described a situation in which Phillips curve effects on inflation are negligible. Low unemployment and generally strong labor markets, despite being in place throughout the forecast horizon, do not put upward pressure on inflation in the forecast we have described. It could be that meaningful Phillips curve effects return and drive inflation higher even though nothing else about the situation as we describe it has changed. This is one risk.

First, we have no reason based on current data to forecast a recession, and so we adopt a “no recession” baseline scenario.


If low productivity magically switches to high productivity ...
If meaningful Phillips curve effects magically return ...
If we are surprised by a recession ...

1 comment:

The Arthurian said...

From the PDF: "The concept of a single, long-run steady state to which the economy is converging is abandoned, and is replaced by a set of possible regimes that the economy may visit."

You could see this as an outgrowth of Jim Bullard's "wealth shock" view from 2012:

"For those who take the “large output gap” view, the expectation is for real GDP to grow rapidly after the recession comes to an end, as the economy catches up to its potential. It is like a rubber band, there is supposed to be a bounce back period of rapid growth...

The wealth shock view puts a different expectation in play. The negative wealth shock lowers consumption and output. But after the recession ends, the economy simply grows from that point at an ordinary rate, neither faster nor slower than in ordinary times. It is more like an earthquake which has left one part of the land higher than another part. There is no expectation of a “bounce back” to a higher level of output after the recession ends.

Since 2012 at least, Bullard has been thinking in terms of alternatives to automatic return to the trend path. Now he has a "new characterization" which lets him think in terms of those alternatives.

And Bullard has reasons for moving to the new characterization. In the paper from 2012 he said "most analysts have been looking for exactly this [bounce back] effect since the summer of 2009. It has not happened." He said the wealth shock view "is closer to what has actually happened since mid-2009."

But there is one thing Bullard doesn't have. He doesn't have an explanation. He can't explain the change from "automatic return to trend path" to the "earthquake" that suddenly shifts the trend path to a new, lower level. He doesn't have an explanation for the sudden shift in trend.

Oh, he's got uncertainty. Sure. But he doesn't have an explanation.

He doesn't have an explanation because, like all the rest of them, he fails to consider the consequences of private debt accumulation.