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How Does the FOMC Learn About Economic Revolutions? Evidence from the New Economy Era, 1994–2001

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Abstract

Forecasting is a daunting challenge for business economists and policymakers, often made more difficult by pervasive uncertainty. One such uncertainty is the reaction of policymakers to major shifts in the economy. We explore the process by which the Federal Reserve Open Market Committee (FOMC) came to recognize and react to the productivity acceleration of the 1990s. Initial impressions were formed importantly by anecdotal evidence. Then, FOMC members—and chiefly Federal Reserve Board Chairman Alan Greenspan—came to mistrust the data and the forecasts. Eventually, revisions to published data confirmed initial impressions. Our main conclusion is that the productivity-driven positive supply side shocks of the 1990s were initially viewed favorably. However, over time they came to be viewed as posing a threat to the economy, chiefly through unsustainable increases in aggregate demand growth that threatened to increase inflation pressures. Perhaps nothing so complicates business planning and forecasting as policymakers who initially embrace an unanticipated shift and later come to abhor the same shift.

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Notes

  1. To track the evolution of FOMC thinking regarding changes in trend, or structural, productivity, we quote extensively from publicly available transcripts of FOMC meetings. In some cases, we have lightly edited the transcript to reduce length and enhance readability. The original transcripts are available on the Federal Reserve Board's website. Comparisons between our quotes and those transcripts are easily made via simple text searches.

  2. All FOMC briefing materials available to the public are materials produced by the Federal Reserve Board staff, in two parts. These are commonly referred to by the color of their covers as the “Greenbook” and “Bluebook.” Additional, ad hoc materials also may be distributed. These materials become public five years after the respective FOMC meetings after redaction of certain material. In addition, materials are prepared for Reserve Bank presidents by their own staffs. So far as we are aware, these materials are not circulated to other FOMC members, nor are they archived to be made available to the public. Romer and Romer [2008] compare the accuracy of forecasts produced by Board staff to those of FOMC members, including the Reserve Bank presidents. The latter do not fare well in the comparison.

  3. This paper is an extension of Anderson and Kliesen [2010], which examines the evolution of FOMC thinking regarding changes in trend, or structural, productivity from the 1980s to 2007. They also quote extensively from publicly available transcripts of FOMC meetings. Federal Reserve staff input to the FOMC consists of two parts. First, the Board of Governors staff prepares material in advance of each meeting. These materials often are referred to by the color of their covers as the “Greenbook” and “Bluebook.” Beginning in 2010, the Greenbook was expanded to include more analysis of financial market conditions, and renamed the “Tealbook.” Additional, ad hoc materials also may be prepared and distributed. Federal Reserve Bank staff also prepare materials for each Bank president. Forecasts and most other briefing materials prepared by the Board staff become public five years after the respective FOMC meeting, although some portions are redacted from public documents. Materials prepared by Federal Reserve Bank staff are not made public.

  4. Such changes are not confined to the United States. See Pilat and Lee [2001] and Colecchia and Schreyer [2002] for a survey of the OECD countries. Armstrong and others [2002] examine the Canadian experience.

  5. See the discussion in Edge, Laubach, and Williams [2004]. Interested readers also should compare Gordon [2000] and Gordon [2003]. In his earlier writings, Gordon argued that productivity had not accelerated in nearly 90 percent of the economy and that trend growth of total factor productivity had actually decelerated. The passage of time, and revisions to the data, have confirmed the shift in trend. The evidence for potential GDP remains mixed, however; see for example Kouparitsas [2005].

  6. See the September. 10, 2000, Blue Chip Economic Indicators or the First Quarter 2001 Survey of Professional Forecasters.

  7. The source documents for Meltzer's book are hosted on the Internet by the Federal Reserve Bank of St. Louis as part of its FRASER project at http://fraser.stlouisfed.org/meltzer/. In this study, we distinguish studies that examine policymakers’ learning processes from studies that argue that the pursuit of alternative policies during specified time periods would have produced superior economic outcomes. We also would omit from the category of policymakers’ learning any circumstance where policy changed due to political pressure rather than learning. Indeed, some such episodes perhaps are best regarded as policymakers suppressing their understanding of the correct monetary policy in order to appease political pressures. Bremner [2004] relates in chapters 9 and 11, respectively, how Presidents Johnson and Nixon successfully pushed Federal Reserve Chairman Martin to compromise his anti-inflationary views. Abrams [2006] demonstrates, via quotations from the Nixon Oval Office tapes, how strong, direct, and persistent pressure was used to induce Arthur Burns to adopt policies wholly contrary to writings in Burn's own 1957 book. Subsequent re-discovery by policymakers of their earlier, more defensible principles is not an example of policymaker learning. Policy learning always includes significant differences of opinion; Meltzer's chapter 8, for example, concisely compares and contrasts such differences prior to 1951. Previous articles written within the Federal Reserve include Kozicki [1997] and Tallman [2003].

  8. Basu and others [2003] compare and contrast the differing U.S. and U.K. experiences after 1995.

  9. This point is made clearly by Triplett [2002].

  10. In the models of Svensson and Woodford [2003, 2004], optimal response to imperfect observation of output (and productivity) depends on the noise in the system. The optimal response to the optimal estimate of output displays certainty equivalence—but what is to be done when different policymakers have different estimates of potential output?

  11. Interestingly, Greenspan would argue in mid-2010 that high growth rates of labor productivity were impeding the natural upswing in job growth that accompanies an economic recovery. See Greenspan interview on CNBC's “Squawkbox,” July 1, 2010. As we will document in this article, this wasn’t the first instance of Greenspan pointing to pernicious effects from rapidly rising labor productivity.

  12. Wynne [2002] discusses in detail the time-line of federal funds rate targets during the 1990s in response to incoming productivity data. Thornton [2006] discusses the FOMC's federal funds rate target beginning September 1982.

  13. One might argue that employing real-time estimates would provide a better sense of the data that actually confronted policymakers at the time. Regrettably, we do not have access to that data (if it exists).

  14. R* can be thought of as the short-term real interest rate path that equilibrates actual output with potential output. The discussion of a negative r* and its implications would also come to dominate the discussion during the 2007–09 recession, as suggested by the debate over the Taylor Rule's implication of a negative federal funds rate.

  15. See the conference volume “Monetary Policy Under Uncertainty,” for a recent treatment of this topic. The papers can be accessed at: http://research.stlouisfed.org/publications/review/article/6547.

  16. In general, the quoted text from the FOMC transcripts in this article has been lightly edited to reduce its length, and formatted into paragraphs to improve readability.

  17. The indicator value of increasing profits as a signal of increased productivity has a long history; see, for example, comments by Richmond Reserve Bank president Edward Boehne during the February 1983 FOMC meeting. The Board staff's productivity trend rate, as of February 1983, was approximately 1 percent, vs. 2–1/2 percent earlier in the post-war period. The Board staff was forecasting actual productivity growth of 2–1/2 percent in 1983 and 1–1/2 percent in 1984, driven by manufacturing with not as much going on in the services sector. In the FOMC transcripts, Board research director Kichline notes that some interesting things happened in 1982. One is that productivity started rising very early.

  18. See Woodward [2000] for a detailed discussion of this episode and the mechanics of the 1996 internal study, which was subsequently published as Corrado and Slifman [1999].

  19. Ramirez and Melville [1998] examine large U.S. firms drawn from the Fortune 1,000 list. While 1,694 firms are observed for at least one year, only 517 firms are observed in all 10 years. Average revenue, profit, and number of employees of these firms aligns well with figures for both the Fortune 500 and 1,000 firms. Seventy variables are available for each firm in each year.

  20. For some perspectives on thoughts at the Board of Governors on the wealth effect during this period, see Gramlich [2002] and Dynan and Maki [2001].

  21. At this meeting, even a discussion of Humphrey-Hawkins money growth rate targets became entangled with productivity growth. Increasing productivity growth implied that more rapid money growth would be consistent with price stability. The Chairman argued against such an increase in target ranges because it would “inexorably” lead to a discussion of the staff's process for developing productivity projections—a topic he did not care to debate or defend in public. Ironically, the Committee accepted the need for reduced disclosure and transparency. The Chairman said: “we have managed to take this whole issue [projecting productivity growth] off the table completely. If we change the [money] targets and we try to explain why, what of necessity is going to come out in the explanation is that we have changed our structural productivity growth measure from 1 to 2¼ percent, and that is something we have avoided doing. All we would be doing if we change them [money targets], as far as I can see, is to open us up to discussing what the staff's trend productivity number is and then we’d get involved in defending it or not defending it. I feel like the politician who spends most of his time trying to avoid having certain questions asked. This is one of those questions I would just as soon not have raised because I think there are differences of view among the people in this room and it would serve no useful purpose of which I’m aware to get into this discussion.”

  22. For discussions of productivity revisions and the national income account revisions, see Anderson and Kliesen [2006].

  23. The zero bound problem arises when a central bank, working with an overnight interest rate as its single policy instrument, finds that the desired setting for that rate is below zero. Nominal interest rates cannot be less than zero (absent a subsidy or partial forgiveness of a debt). If the policy rate is at the zero bound and inflation is falling, then the real policy rate will be increasing; if, in turn, this further attenuates economic activity such that inflation falls further (or becomes negative), a cumulative process might be launched that drives the economy into an extended downward spiral.

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Acknowledgements

We thank Charles Gascon, Michael Cassidy, Tom Pollman, Giang Ho, Aeimit Lakdawala, Marcella Williams, and Linpeng Zheng for research assistance.

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  1. Richard G Anderson
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Views expressed are our own and not necessarily those of the Federal Reserve Bank of St. Louis, the Board of Governors of the Federal Reserve System, nor our friends and colleagues.

*Richard Anderson is economist and vice president in the research division of the Federal Reserve Bank of St. Louis, where he researches the behavior of financial markets. He also is the Leverhulme Trust Visiting Professor (finance), Management School, University of Sheffield, Sheffield, U.K. Prior to joining the St. Louis office of the Federal Reserve, he was an economist in the Division of Monetary Affairs at the Board of Governors of the Federal Reserve System, Washington D.C., and taught at the University of Michigan, Ohio State University, Michigan State University, and Virginia Tech's Northern Virginia graduate center. He was visiting professor, Aston Business School, Aston University, Birmingham, U.K., from 2005 to 2010. He earned a bachelor's degree in economics from the University of Minnesota-Minneapolis and his Ph.D. from the Massachusetts Institute of Technology. Kevin L. Kliesen is a business economist in the Supervisory Policy and Risk Analysis Unit at the Federal Reserve Bank of St. Louis, which is located in the Bank Supervision and Regulation Division. His primary duty comprises reporting on and analyzing current U.S. and international macroeconomic and financial developments and trends for the Board of Directors, Bank president, and staff economists. He also developed (with a former colleague) the St. Louis Financial Stress Index. In addition to his responsibilities at the Federal Reserve Bank of St. Louis, he has taught part-time for the Department of Economics at Washington University in St. Louis since 2006. In September 2011, he was recognized as a NABE Fellow, one of the organization's highest honors. He joined the Bank in 1988 after graduating from Colorado State University with an M.A. in Economics.

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Anderson, R., Kliesen, K. How Does the FOMC Learn About Economic Revolutions? Evidence from the New Economy Era, 1994–2001. Bus Econ 47, 27–56 (2012). https://doi.org/10.1057/be.2011.36

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