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Fed’s rose-coloured glasses may cloud its judgement

Federal Reserve chairman Ben Bernanke appears before the U.S. House Financial Services Committee last month to deliver his twice-a-year report to Congress on the state of the economy.

J. Scott Applewhite/Associated Press

With the U.S. Federal Funds rate at zero, those who believe the Fed is 'out of ammunition' to boost the economy would be satisfied with Ben Bernanke's muted performance of late. For the rest of us, it's hard to comprehend the central bank's ongoing policy failure. So, let's assume the Fed still has some ammo in the monetary policy arsenal. The question then becomes, "what is possibly stopping the Fed from doing more?"

Conspiracy theories that Mr. Bernanke is intentionally tanking the U.S. economy in order to get Mitt Romney elected should be dismissed out of hand. There is no evidence that the Fed chairman is intentionally making the lives of millions of Americans worse off for political gain. Furthermore, Barack Obama's Fed nominees have been broadly supportive of the Federal Reserve's monetary policy stance.

Economist Evan Soltas recently published revealing data that helps to explain the Fed's monetary policy failures. Mr. Soltas compared the Fed's forecasts of GDP growth and unemployment from 2009 to the present with what actually happened. In every single case, the Fed's forecasts were, in retrospect, laughably optimistic. Or as Mr. Soltas phrases it, "the Fed makes projections, misses them by miles and consistently in the wrong direction".

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If the Federal Reserve's predictions had been accurate, then U.S. monetary policy over the last four years may have been appropriate. The economy would have got better on its own, so loosening monetary policy would not have brought added prosperity, just added inflation.

Unfortunately, this answers one question by creating another. Why was the Federal Reserve putting out predictions that turned out to be so inaccurate? It cannot be explained by stating that there were unexpected shocks, as market forecasts were far more bearish than the Fed (and were ultimately closer to being correct). The next time Ben Bernanke takes questions on Capitol Hill, it would be greatly helpful if he were asked why the Fed's forecasts have been so far from the mark and so overly optimistic.

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