Amidst shifting economic landscapes, former Fed Chair Ben Bernanke advocates for embracing alternative forecasting methods.
The Federal Reserve’s traditional forecasting model is under scrutiny as the economy experiences unexpected fluctuations, rendering its predictions increasingly outdated. Rather than solely relying on a single central projection, which often proves inaccurate, experts argue for adopting scenario analysis to better capture the range of potential outcomes in a post-pandemic economy.
Scenario analysis, gaining traction as a viable alternative, involves considering various credible risks alongside potential central bank responses. Dartmouth College professor Andrew Levin likens it to “stress tests for monetary policy,” emphasizing its utility in times of heightened economic uncertainty.
Former Fed Chair Ben Bernanke echoes this sentiment, advocating for scenario analysis in a recent report to the Bank of England. He suggests that presenting both central and alternative scenarios would enable the public to better anticipate future policy actions, a practice already adopted by some central banks like Sweden’s Riksbank.
The Fed’s reliance on median estimates for growth, unemployment, inflation, and interest rates may overlook the diversity of opinions among policymakers, particularly in volatile economic environments. This was evident when unexpected inflation data quickly rendered previous projections obsolete.
While Fed staff economists conduct scenario analyses internally, these are not disclosed publicly in a timely manner, limiting their effectiveness for communication purposes. The New York Fed’s practice of soliciting probabilities from Wall Street dealers for different policy outcomes could offer a more transparent approach.
Despite challenges in implementing new communication practices, there is growing recognition among Fed officials for the need to embrace alternative forecasting methods. Cleveland Fed President Loretta Mester and Minneapolis Fed President Neel Kashkari have expressed openness to scenario analysis, indicating a potential shift in the central bank’s approach.
As the Fed prepares for another policy framework review later this year, there is anticipation that Bernanke’s advocacy for alternative forecasting methods could prompt further innovation in central bank communications practices.
