Fed is no slave to economic models

Fed officials say they aren’t slaves to economic models and that while the models help them think about problems, they don’t dictate their responses.

The Fed uses computer-modeling programs to make predictions about how various policies and events will play out across the economy. The main economic model launched in 1995 is called FRB/US, or: Ferbus. 

Ferbus uses hundreds of different mathematical equations to describe how the economy works. Punch in a lower interest rate, and Ferbus spits out predictions of how much growth and inflation should follow.

Punch in some other event—like a sudden contraction in government spending or a jump in tax rates—and it spits out predictions of how the economy should respond.

Smaller-scale models since have been developed, with more advanced techniques, named Edo and Sigma. The fingerprints of Ferbus and its friends are all over the Fed’s latest interest-rate decisions.

In two important speeches this year, Fed Vice Chairwoman Janet Yellen described in detail how she and Fed staff used the models to gauge how long interest rates could remain low without generating too much inflation, though she acknowledged in the speeches it would be “imprudent to place too much weight” on the models.

But the forecasting models don’t dictate the Fed’s responses. “Model results are just one input into forecasting and policy analysis,” said Michael Kiley, a Fed economist and senior modeler.

Source: Wall Street Journal