Mugged By Reality; Many Still Yet To Be Convinced

In August 2014, Federal Reserve Vice Chairman Stanley Fischer admitted to an audience in Sweden the possibility in some unusually candid terms that maybe they (economists, not Sweden) didn’t know what they were doing. His speech was lost in the times, those being the middle of that year where the Fed, having already started to taper QE3 and 4, was becoming supremely confident that they would soon end them. At Janet Yellen’s first press conference as Chairman earlier that year, the idea was raised that just six months would pass between QE’s termination and the first rate hike, such was the economic favorability.

So it became mainstream gospel that the economy was more in danger of “overheating” than it was of either continuing stuck or, as did happen, severely diminishing even more. There was a great deal of disbelief at that latter scenario given that such would be so unthinkable; after so much “stimulus” and enough time, there was just no way the US economy would not at some point recover, and do so in the familiar fashion.

Fischer told the assembled Swedes that the mistakes of forecasting made by the Fed’s staff just might be more than a throwaway joke about how economists were weathermen in different clothes.

Year after year we have had to explain from mid-year on why the global growth rate has been lower than predicted as little as two quarters back. Indeed, research done by my colleagues at the Federal Reserve comparing previous cases of severe recessions suggests that, even conditional on the depth and duration of the Great Recession and its association with a banking and financial crisis, the recoveries in the advanced economies have been well below average.

He would name three “headwinds” that were, in his, and likely the FOMC’s, estimation holding growth back – housing still struggling somewhat of its hangover, the drag of fiscal policy (austerity, as the Keynesians emotionally label it) which was waning according to Fischer, and overseas weakness. If that was the comprehensive catalog of all “headwinds” in the summer of 2014, then “overheating” was plausible.

However, he struck a more cautious tone that, again, went largely unnoticed but would become central to the Fed’s ultimate “rate hike” case that goes forth today.

Possibly we are simply seeing a prolonged Reinhart-Rogoff cyclical episode, typical of the aftermath of deep financial crises, and compounded by other temporary headwinds. But it is also possible that the underperformance reflects a more structural, longer-term, shift in the global economy, with less growth in underlying supply factors.