Persistent Uncertainty for Economic Policymakers
The uniqueness of the most recent recession and its connection to a financial crisis has provided many challenges to policymakers, including the FOMC. The subsequent recovery, which is slowly progressing, still features a number of factors that are creating uncertainty about when the economy might return to a more normal trajectory. The most recently released FOMC minutes, for example, state that “nearly all of the participants judged their current levels of uncertainty about real GDP growth and unemployment to be higher than was the norm during the previous 20 years,” and that “participants noted the challenges associated with forecasting the path of the U.S. economic recovery following a financial crisis and recession that differed markedly from recent historical experience.” Chairman Bernanke has also commented on the extraordinary level of uncertainty in the economy on several occasions.
Since economic policies are based not only on current condtions, but also on how the economy is going to evolve, forecasts provide market participants some basis for judging how policy will evolve if the economy deviates from its project path. When uncertainty increases, it should be reflected in a larger dispersion of forecasted macroeconomic variables. The Survey of Professional Forecasters (SPF), which is a quarterly survey of macroeconomic forecasts in the United States, provides a measure of dispersion for forecasts of each of the macroeconomic variables included in the survey. A higher level of dispersion suggest a larger discrepency in forecasts, and thus more uncertainty, while a smaller dispersion suggest more agreement among forecasters, meaning that the level of uncertainty is potentially lower.
The chart below shows a four-quarter moving average of the dispersion, measured as the interquartile range, of SPF forecasts for GDP growth, inflation, and the unemployment rate for four quarters in the future. During the recent recession, dispersion spiked for all three variables, suggesting that there was less agreement from forecasters about the future course of the economy. This measure of uncertainty was generally higher after the recession than it had been over the previous ten years, especially for forecasts of GDP growth, and the higher level persisted for some time. Recently, dispersion has begun to come down to more normal levels, suggesting that uncertainty among forecasters has been declining over the past eight quarters.
Alternative perspectives are presented in the FOMC minutes. The minutes of the December meeting included the FOMC’s Summary of Economic Projections for GDP, inflation, and the unemployment rate (SEP). Along with these projections, the SEP includes a survey of each participant’s assessment of uncertainty regarding his or her economic projections, compared with the last 20 years for each of the projected variables. In addition, members are asked to assess the distribution of risk—whether is it weighted to the upside or downside, or broadly balanced.
As of the December meeting, FOMC participants generally saw uncertainty related to projections of GDP as higher than it has been in the last 20 years. Only one participant saw uncertainty as broadly balanced, and zero participants saw uncertainty as lower than it has been in the past. This is largely unchanged from the projections reported with the June and September FOMC minutes. More precisely, a majority of participants see the risks to GDP growth as weighted to the downside, meaning that they see a greater potential for GDP growth to turn out lower than expected. However, a growing number of participants did see risks as broadly balanced, meaning that they see some potential for GDP growth to be higher or lower than they project.
Uncertainty about projections of the unemployment rate was similar to uncertainty regarding GDP growth. A majority of participants saw uncertainty about unemployment as being higher than it has been in the past two decades, while only a few see uncertainty being similar to what it has been in the past. The participants generally reported that they saw the risks to the unemployment rate as weighted to the upside, meaning that they saw some potential for the unemployment rate to be higher than expected, given the uncertainty. In contrast to the GDP growth projection, the balance of risks remained unchanged over the past three sets of FOMC projections (April, June, and September).
Unlike uncertainty about GDP and unemployment, uncertainty regarding the projections of inflation has been declining, compared with the past two sets of SEP projections. A majority of participants saw uncertainty about inflation as broadly similar to the level of uncertainty over the past 20 years. Additionally, an increasing number of participants generally saw the risks to inflation as broadly balanced.
It has been more than three years since the end of the last recession, and uncertainty, measured either using differences in forecasters’ predictions about the future or by policymakers’ perceptions of their own projections, still remains high. As the recovery continues, and conditions continue to normalize, uncertainty should continue to come back down to more normal levels.