If the Federal Reserve’s forecast is right, the central bank’s target interest rate might peak Wednesday at 5 percent. There’s a caveat: The forecast might be wrong.
As policymakers gather for their rate-setting meeting, Chairman Ben S. Bernanke is counting on the Fed’s prediction of a coming slowdown being accurate enough to allow a pause in rate increases. At the same time, even those who have been responsible for such forecasts in the past caution it is far from infallible.
“There are many sources of error, and we made them all,” said Michael Prell, the Federal Open Market Committee’s chief forecaster from 1987 to 2000 and now a member of the board of advisers to St. Louis-based Macroeconomic Advisers LLC. “Many forecasters do.”
Bernanke, said Prell, “has been more willing to embrace some notion of the consensus view with greater explicitness” than his predecessor, Alan Greenspan.
The Fed will lift its benchmark rate to 5 percent from 4.75 percent, its 16th consecutive increase since June 2004, according to all 72 economists surveyed by Bloomberg News.
The bigger decision for the Fed might be how to signal to markets that plans for a breather could change. Bernanke told Congress’s Joint Economic Committee last month that the tightening might be suspended for at least one meeting.
Bernanke has waded into “the perils of transparency,” said Ian Morris, chief U.S. economist at HSBC Securities USA Inc. in New York.
With the chairman having given the markets a map of the central bank’s outlook that’s now challenged by a series of strong economic reports, “bond traders will take a Fed pause so long as growth slows.”
If it doesn’t, said Morris, whose firm is a primary government bond dealer that deals directly with the Fed, “you could get a very violent sell-off.”
A 2002 study covering about two decades of data by William Gavin and Rachel Mandal of the St. Louis Fed concluded that the year-ahead forecast of Fed policymakers on growth and inflation is no better than those of private economists.
In the years since, Fed members underestimated growth in 2003 and overestimated the expansions of 2004 and 2005. Predictions for inflation were accurate in 2003 and too low in 2004 and 2005.
Policymakers said in February that the economy will grow about 3.5 percent this year with inflation of 2 percent, excluding food and energy costs. Gross domestic product increased at an annual rate of 4.8 percent in the first quarter, the fastest pace in more than two years, and there’s little evidence of a slowdown so far: The expansion in service industries is picking up, the jobless rate hasn’t been lower in four years, and wages are increasing.
A price index tied to personal consumption, excluding food and energy, rose 2 percent in March from a year ago, the top of Bernanke’s comfort zone.
