Let me begin by wishing Happy New Year to all my readers. I admit, life is not economics alone. However, let’s take a look about how the 2021 would be? When it comes to economic projections, I have more faith in none other than the Federal Open market Committee (FOMC). It is not that FOMC doesn’t make errors. It is FOMC composition and their data- driven process that attracts me.
FOMC comprises 12 members including 7 member of the Federal Reserve Board and five (of the total 12) Presidents of the District Federal Reserve Banks, by rotation. FOMC meets approximately every 6 weeks to review and determine Federal Funds Rate (FFR) range.
FFR is the rate at which banks can borrow from each other to meet short term liquidity needs. FFR is the key to market interest rates. Market interest rates are the rates households and businesses pay to borrow funds in the market or receive on their deposits. When FFR goes up, market interest rates go up. When FFR goes down, market interest rates go down.
In determining FFR range, FOMC uses extensive sets of data presented in Teal Book (A and B) and Beige Book. Teal Book-A presents information and data about economic and financial conditions- current situation and outlook. Teal Book- B presents monetary policy strategies and alternatives. The Beige Book presents info and data about current economic conditions across the 12 Federal Reserve Districts. It characterizes regional economic conditions and prospects.
The summary of economic projections issued by the Federal Reserve on December 16, 2020, notes “In conjunction with the Federal Open Market Committee (FOMC) meeting held on December 15–16, 2020, meeting participants submitted their projections of the most likely outcomes for real gross domestic product (GDP) growth, the unemployment rate, and inflation for each year from 2020 to 2023 and over the longer run.” Figure-1 presents the summary projections, as follows:
A quick view of Figure -1, for 2021, highlights as follows:
- Real GDP (GDP adjusted for inflation) would grow in the range of 0.5 – 5.5%.
- Unemployment rate would be in the range of 4.0- 6.8%.
- Inflation would be in the range of 1.2 – 2.3%.
This all sounds like recovery. Overall, good news.
But as the future is uncertain, no one can forecast with 100% accuracy. Indeed, confidence levels of 90% and above are generally acceptable. The summary economic projections also share the participants’ assessment of uncertainty and risks around their economic forecasts, as given below:
Clearly, uncertainty about projections is high.
In a country, where share price of a company goes down if company’s actuals are less than expected (forecast average) , without talking about for the level of confidence of the expectations, ab initio, or the range of possible error of forecast, the following table is very informative and educative.
The following table shows the projection error ranges (Percentage points). These numbers are based on average historical projection error ranges, observed in forecast by various private and government forecaster, over 2000- 2019. The level of confidence of these numbers is 70%.
The Summary report, so very aptly, cautions that, “The economic projections provided by the members of the Board of Governors and the presidents of the Federal Reserve Banks inform discussions of monetary policy among policymakers and can aid public understanding of the basis for policy actions. Considerable uncertainty attends these projections, however. The economic and statistical models and relationships used to help produce economic forecasts are necessarily imperfect descriptions of the real world, and the future path of the economy can be affected by myriad unforeseen developments and events.”
Author would like to gratefully acknowledge that this article has extensively drawn from https://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20201216.pdf