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May 15, 2005

Economist's View: The Art and Practice of Fed Watching

Mark Thoma introduces Tim Duy:

Economist's View: The Art and Practice of Fed Watching: I am pleased to announce a regular feature at Economist's View. Tim Duy, whose qualifications are noted here, has agreed to resume his formal role as Fed Watcher for us on a regular basis. Here are Tim's thoughts on the art of Fed Watching:

Raised From The DeadI seemingly gave up my career as a Fed Watcher more than three years ago, choosing instead to reinvent myself as a local and regional economist in an effort to build a life in the Pacific Northwest (I am hoping global warming increases rain in the region. I understand there is a 50-50 chance of that outcome). Under some congenial prodding from Mark Thoma, however, I am warily putting my feet back in the water.

Some initial observations on Fed Watching, so I can establish something of a baseline:

  1. I do not claim to have any special contacts with members of the Federal Reserve. To be sure, I know economists who work or have worked at the Federal Reserve Board of Governors or District Banks, but I am not pumping them for inside information.
  2. I do not believe that there are mountains of secret information about Fed policy waiting to be discovered. Of course, on occasion a loose piece of information may slip via a private conversation from someone closely connected with the Fed. But such slip ups are relatively rare, especially as the Fed has become increasingly transparent.
  3. As a corollary to point 2 above, I am amazed that investment firms will pay thousands of dollars for the inside scoop on the Fed. My recommendation is to buy a subscription to the Wall Street Journal. Greg Ip is more likely than anyone else to get the story right (except me, of course!). I expect some angry comments back on this one.
  4. The secret to remember is that Fed Watching is not about your interpretation of the economy or what you would do if you were a Board member. That approach will lead you down a bad road. The secret is to interpret the data as the Fed sees it, and remain agnostic about whether the policy is wrong or right.
  5. The worst screw ups will happen when the Fed switches gears in their policy stance. The Fed Watcher must both anticipate a turn in the economy and the Fed's timing of any reaction. Given that economists have correctly predicted something like 8 of the past 5 recessions, a shift in the business cycle will likely leave the Fed Watcher bloodied (been there, done that).
  6. One should be aware of what is happening on Wall Street, but not be overly influenced by the day to day noise. It is easy to get carried away in the hype.
  7. Read the speeches of Fed officials, particularly Board members. Speeches from District Bank Presidents may be interesting and insightful, but policy is made in Washington (New York is the exception to this rule).
  8. Everything will change next year. Be wary -- no matter who replaces Greenspan, he (or, in a bow to political correctness, she) will be fresh blood, and thus a mystery. Uncertainty is the bane of financial markets....

Fed policymakers keep a careful eye on global developments, to be sure. But policy remains focused on domestic stabilization. And also, all economies should maintain a similar focus.... [T]he Fed will keep watch on the current account deficit, and consider how to respond to the challenges a sudden stop of capital would create, but are unlikely take policy action directed toward the current account. Likewise, there may in an asset bubble in the housing market, but don't expect the Fed to react to that, at least not before it bursts. What to look for then? Growth, jobs, and inflation. Boring, I know, but these are the tried and true friends of any Fed Watcher....

Posted by DeLong at May 15, 2005 06:43 PM