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Fed Forecasting Model Is ‘Broken,’ Austan Goolsbee Charges

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Former Obama administration official Austan Goolsbee took to the Morningstar Investment Conference main stage in Chicago on Tuesday, making predictions about the economy and suggesting why it is that the Federal Reserve has been “overly optimistic for 30 quarters in a row” on forecasting U.S. economic growth.

“Each quarter there’s a different reason” the Fed offers for the now six-year-old sluggish recovery, Goolsbee said, whether it’s an extremely cold winter or the effects of a Chinese economic slowdown, or “now the British are going to leave the EU.”

Those are not the problems, he argued. “The forecast model is broken,” said the University of Chicago economics professor and former chair of the White House Council of Economic Advisers. The problem is that the Fed model is “implicitly waiting for things to go back to ‘normal,’” Goolsbee said, but the Fed’s model “defines normal as a mean reversion—what happens to the economy when house prices grew 8.5% a year,” which is when consumers started spending and the economy grew. The Fed “defines normal as 2006, which isn’t happening again, because it was a bubble. It was not sustainable.”

Now the Fed is forecasting renewed healthy growth, with 2017 as “the year we will take off” and achieve the much-desired but so far elusive V-shaped or even U-shaped recovery. “I used to joke with Ben Bernanke when I was in the White House,” he said, that Bernanke was trying to modify Fed policy to make true the famous Onion headline: “Furious nation demands new bubble to invest in to restore prosperity.”

Will housing “be the savior” of the economy, he asked? Asking the audience if they believe housing and real estate will “go back to being a slow, steady asset or do you think it’s going back to the go-go days” of the 2000s, he answered by saying that the only way to deliver a U-shaped recovery “is if we go back to the go-go days.”

(Related: Gundlach Blasts Policies of ‘Zombie Fed,’ Negative Rates)

What about the consumer as economic savior? “Consumers in the 2000s literally spent more than their assets were growing; the national savings rate was negative. That’s not a sustainable growth model.” What’s the likelihood that consumers now “will go back to a negative half-percent savings rate like we did in 2005-2006?” His conclusion: “Consumer spending will only be a modest contributor to GDP.”

He ended his Fed comments by suggesting that “If you’re waiting for the 2006 normal bus to come back, pick you up and bring you back to prosperity, you’re actually hitchhiking. The bus is not coming back.”

Goolsbee then took his own stab at forecasting economic growth in general and prospects for several asset classes, prefacing his predictions with the disclaimer that his listeners should be skeptical about all forecasts “in a world where a third of all government bonds issued worldwide carry a negative interest rate, Donald Trump could be the next president and the World Series favorite is the Chicago Cubs.”

U.S. GDP growth of 2% or so should continue for the next 12-18 months, he said (the Fed itself revised downward Tuesday its 2016 GDP growth to 2.0% from 2.2%).

What are the chances of a recession? Since most previous U.S. recessions were preceded by high oil prices, he thinks it unlikely now in the wake of steadily low oil prices. Moreover, he said oil prices don’t affect the U.S. economy as they used to, that the sharp drop in oil prices is more likely to have been driven by slowing demand for oil and that “oil’s fall has correlated with just about every other commodity.”

Goolsbee’s own prescription for restoring more robust economic growth includes taking better advantage of our strong “human capital” and the continuing productivity of our workers, pointing out that of all the major industrial nations, the U.S. has the best rate of productivity growth.

“Our long-run prospects are superb,” he concluded, “but not in the next 12-18 months.”

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