Setting Gene Epstein Straight

Some of you may be aware -- though most of you probably not -- that the proprietor of macroblog finds himself in a period of transition.  As the first sign of stress is referring to one's self in third person, let me apologize retrospectively and in advance for a period of slow blogging.  Things will, I hope return to normal productivity soon, but for today I will turn to my friend and colleague Mike Bryan, writing at the Cleveland Fed website:

Last week, Federal Reserve Board Chairman Bernanke made his midyear appearance on Capitol Hill to testify about the economy and monetary policy. Among his duties at these semiannual events is the release of the economic projections, the most recent vintage of which can be found here.

Gene Epstein of Barron’s offered his perspective on the projections (available by subscription here). He argues that, in retrospect, Chairman Bernanke’s outlook for 2006 was fairly wide of the mark in all three of the major variables—real growth, the rate of unemployment, and core inflation... But these were fortuitous errors, says Mr. Epstein, because had the Chairman seen that growth was coming in at 3.1 percent rather than the 3.5 percent projected, he might have projected unemployment to be higher and inflation to be lower, weakening “his resolve to keep hiking the interest rate,” which would have been “ill-advised.”

Mike has some problems with that take on the situation:

First, the central tendency of the semiannual economic projections reported by Gene Epstein is not necessarily the Chairman’s personal view. All Reserve Bank presidents and Fed governors offer a projection, and where the Chairman’s view lies in that set of projections cannot be determined.

In other words, the semiannual economic projections are not the prognostications of an individual, but the wisdom of a crowd:

... one article of particular interest... [authored by the St. Louis Fed's Bill Gavin] is worth repeating here. Gavin demonstrates that the midpoint taken from the full range of policymakers opinions is a better predictor of future outcomes than the group’s central tendency (which is calculated by Federal Reserve Board staff by excluding projection outliers.) While Gavin didn’t speculate on why the midpoint of the full range of Federal Reserve forecasts is superior to the group’s central tendency, I will.

Economic forecasting is a hard business and no thoughtful forecaster enters the forecasting arena without a healthy skepticism about his or her ability to see the future—a future full of unknowns. And these unknowns—risks—can sometimes be revealed by the range of opinions coming from people who see and judge them differently. In the case of the 2006 outlook, the outcomes were within the full range of Federal Reserve officials opinions for unemployment and core inflation, and just marginally under the bottom end of the range of opinions for real GDP growth (3.1 percent vs. 3.25 percent).

Most importantly, thinking that policymakers slavishly base their decisions on the point estimates derived from a forecasting exercise is -- well, wrong thinking:

Perhaps the real usefulness of economic forecasts is not their ability to see what will come next, but rather their ability to identify the risks that stand the best chance of causing the projection to go amiss. And these risks are also articulated in the Chairman’s testimony. In his February 2006 testimony, Chairman Bernanke described three such risks in the 2006 outlook. First, there was a potential for slower real growth due to problems associated with housing; second, high rates of resource utilization could add to inflation pressure; and third, “[a]dditional steep increases in the price of energy [c]ould intensify cost pressures and weigh on economic activity.”

Well, we can quibble over the accuracy of last year’s economic projections, but it’s hard to find fault with the assessment of the risks we faced.

Exactly.