BASED ON DATA RELEASED LAST WEEK, Ben Bernanke’s track record on forecasting growth in gross domestic product is two-for-two — an impressive showing for his first year as Federal Reserve chairman. But since he’s zero-for-two in forecasting the unemployment rate, it does make you wonder if he has any misgivings about holding the line on the short-term interest rate. Does he now secretly believe he would have been wiser to raise it a notch or two?
This scorecard on Bernanke is not based on any forecast he made recently, but on the forecasts all Fed chairmen make in testimony before committees of the House and Senate in February and July of each year. Since that testimony accompanies the Federal Reserve Board’s “Semiannual Monetary Policy Report to the Congress,” the projections represent his team’s most visible effort to get the outlook right.
The need to get the outlook right was emphasized by Bernanke himself, in his own testimony of July ‘06. Because of the “lags between policy actions and their effects,” he declared, “we must be forward-looking, basing our policy choices on the longer-term outlook for both inflation and economic growth.”
Similar views were expressed repeatedly by Ben Bernanke’s illustrious predecessor, Alan Greenspan. Yet based on his own testimony before Congress in February and July, Greenspan’s track record in forecasting economic growth was poor by any standard. So far, at least, Bernanke has done much better.
The forecast given for growth of real GDP is measured as the percentage change in fourth-quarter GDP from the fourth quarter of the previous year.
We can judge Greenspan’s track record according to the easiest standard possible — the “range” rather than the more narrow “central tendency” — and still find it lacking. In the last 12 years of his chairmanship — from 1994 through 2005 — his February forecast turned out to be right only once. That is, only once did the actual rate of GDP growth come in within the range given.
As you might expect, however, his July forecast proved to be more accurate, since by then the fourth quarter is only three months away. Over the same 12 years, his July forecast turned out to be right twice. That is, only twice did the actual rate of GDP growth come in within the range given.
By contrast, Chairman Bernanke not only got GDP growth right in both February and July of his very first year; he also got it right according to a more stringent standard. Based on data released last week, we now know that in fourth-quarter 2006, real gross domestic product ran 3.4% higher than a year ago. And in both February and July, that fell within the range of the central tendency offered by Bernanke.
But if he was two-for-two on GDP growth, he was zero-for-two on the unemployment rate. As of both February and July, his central tendency for the unemployment rate through the fourth quarter was 4¾% to 5%. In fact, the unemployment rate averaged 4.5% in the fourth quarter. And if even if you tacked on the January reading of 4.6%, released Friday, you’d still average 4.5% from November through January.
In other words, the Fed chairman underestimated the tightness of the labor market — a mistake that sounds eerily familiar. Through the late 1990s, his predecessor made the same error and was eventually forced to raise the short-term interest rate too far and too fast. True, Bernanke can point to signs that wage inflation still looks relatively tame. But he is not the sort of Fed chairman who prefers to wait until he sees the whites of inflation’s eyes.
The upside surprise of fourth-quarter GDP growth might be having a delayed impact on him. When he delivered his July testimony, he had just finished hiking the interest rate target on federal funds to 5.25%. And when the Federal Open Market Committee decided to keep the fed-funds rate at 5.25% at its Dec. 12 meeting, it erroneously stated in its press release: “Economic growth has slowed over the course of the year.”
At its meeting last week, on Jan. 31, the FOMC again decided to keep fed funds at 5.25%. But that was only shortly after it learned that, far from slowing, economic growth had accelerated in the fourth quarter. This time, the FOMC release acknowledged: “Recent indicators have suggested somewhat firmer economic growth.” In fact, that “firmer economic growth” was the only reason the Fed chairman’s July and February forecasts for GDP growth proved correct.
So we might imagine the Fed chairman rereading his testimony with some satisfaction. My guess is that, over the next few months, he’ll be keeping close watch on the unemployment rate. If it doesn’t rise to that central tendency of 4¾% to 5%, he may start tightening fed funds to nudge it up there.