Tuesday, May 13, 2014

Chart of the Day: The Fed’s Forecasting Models are Broken

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(hat tip Prof John Cochrane)

This Bloomberg article shows that the Fed Chair Ms. Yellen has also been concerned over "broken" inflation forecasting models:
Federal Reserve Chair Janet Yellen is concerned that the standard models central banks use to forecast inflation may be broken.

Behind her disquiet: the failure of the models to foresee the path of prices in the U.S. during the last recession and its aftermath and in Japan during its deflationary period from 1998 to 2012. U.S. inflation has been higher than the simulations suggested, while Japanese price declines proved more persistent.

Yellen alluded to her concerns in a speech last week, saying the Fed has to “watch carefully” to see if inflation picks up as the central bank projects -- and hopes -- during the next few years.
From broken GDP to inflation forecasts, yet whatever the monetary politburo says financial markets seem to believe them. [As a side note: This applies not only to the Fed but to other central banks as well.]

The great Austrian economist Ludwig von Mises tells us why they will keep making the same mistakes:  (bold mine)
In the equations of mechanics we can introduce constants which have been determined with reasonable exactness through empirical experimentation. In this way we can ascertain unknown quantities from given data with an accuracy sufficient for technology. In the field of human action, however, there are no such constants. The equations of mathematical economics are therefore useless for all practicai purposes

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