For years we’ve said that the Fed has defective economic models and the worst forecasting record of any major official institution (although the IMF gives the Fed a run for their money in terms of bad forecasts). The facts back up our claim.
For eight years in a row, from 2009–2016, the Fed’s one-year forward forecast for annual economic growth was off by orders of magnitude. It is only in the past two years that the Fed forecast has become more accurate, and that’s only because the Fed simply trimmed their forecast to the prevailing nine-year trend growth rate of just over 2%. Better late than never.
Not only was the Fed wrong about growth, but they overestimated inflation and expected wage increases at the same time. There are many reasons for this horrible record, including the use of equilibrium models to describe a nonequilibrium complex dynamic system.
Perhaps the Fed’s biggest analytic and forecasting blunder is their reliance on the Phillips curve, which describes a purported inverse relationship between inflation and unemployment. The hypothesis is that as unemployment goes down, inflation goes up and vice versa. There is no evidence for this theory.
In the late 1960s we had low unemployment and rising inflation. In the late 1970s and early 1980s we had high unemployment and high inflation. Today we have low unemployment and low inflation. There is no correlation between employment and inflation at all.
The Fed has been pondering this lack of evidence as shown in this article. The Fed has concluded that they don’t really understand the relationship between employment and inflation. That’s a start.
Maybe I can help. The reason they don’t understand the relationship is because there is no relationship. Inflation is not catalyzed by employment or money supply. Inflation is a result of psychological expectations and the behavioral hypersynchronicity of consumers acting on those expectations. If people believe inflation is coming, they will act accordingly en masse, the velocity of money will increase and soon enough the inflation will arrive unless money supply has been severely constricted.
Just don’t expect the Fed to catch on anytime soon.