“ … human beings have a natural tendency to manage risk after the fact.”
Michael A. Gayed, Pension Partners
If I were betting on the ponies, Janet Yellen (or any Federal Reserve Board member, for that matter), would not be my first choice to bring along for consultation.
As we’ve previously pointed out, the Fed’s forecasting record is pretty lame. The Fed has consistently projected a higher level of growth for the economy than we’ve actually seen (although even Fed projections are consistently well below the 3.3% average growth the economy enjoyed in the years between the end of World War II and the financial crisis). 
The Fed projected growth rate for 2015 was 2.6% to 3%. While it’s too early to tell what the final numbers will be, the just-released latest estimate from the Bureau of Economic Analysis (BEA) for the third quarter of 2015 was 2.0% (down from its previous estimate of 2.1%), which isn’t too far off from the 1.5% growth rate for the first half of 2015.
As David Stockman noted, “Notwithstanding the most aggressive monetary stimulus in recorded history – 84 months of ZIRP and $3.5 trillion of bond purchases – average real GDP growth has barely amounted to 50% of the Fed preceding year forecast; and even that shortfall is understated owing to the BEA’s systemic suppression of the GDP deflator.”
According to Stockman, the Fed’s forecasting model “is an obsolete Keynesian relic which essentially assumes a closed U.S. economy and that balance sheets don’t matter.” More specifically, the economic globalization that’s taken place since late in the 20th century and the worldwide debt of $225 trillion, which has increased 550% in the past two decades, are not considered in economic forecasts.
Why It Matters
So why does the Fed’s inability to forecast accurately matter?
Because Fed decisions, such as its decision to raise interest rates this month and future decisions to potentially continue raising rates, are based on the Fed’s forecasts.
Gradually raising interest rates to a normal level without wreaking havoc on financial markets and the economy would be difficult enough even if the Fed were using the most accurate economic forecasting tools available. Normalizing rates based on a blatantly faulty forecasting model is almost certain to have catastrophic results.
Judge for yourself whether you think the Fed’s eternally rosy projections are politically motivated, whether the Fed is trying to stoke consumer confidence or whether it’s a result of using models created 50 years ago. Regardless, the outcome will be the same.
Just how precarious the Fed’s rate-lifting job will be was noted by Pension Partners: “While it seems ambitious to think that (Fed Chair Janet) Yellen will be able to pull off hiking rates four times ‘gradually’ next year, the reality is that the Fed has to move fast to normalize rates to have any kind of a shot at being effective in fighting the next recession. The irony, of course, is that in hiking rates aggressively to have ammunition for a recession, the stock market could cause one.”
Yet, as we’ve noted, the next recession may already be upon us … or just around the corner.