The Fed's broken crystal ball

By Chris Isidore, senior writer


NEW YORK (CNNMoney.com) -- How nervous should investors be about the Federal Reserve being more nervous?

The latest forecasts from the Fed released Wednesday cut estimates for economic growth, predicted that high unemployment will be more persistent than previously thought and raised the risk of a fall in prices, or deflation, which in itself can cause businesses to cut output and staffing.

Still, investors seemed to shrug off the outlook. Stocks drifted lower immediately after the Fed forecasts were released at 2 p.m. Wednesday, then rallied in the last 90 minutes of trading to end little changed from the previous session.

That may be because growing concerns about U.S. economic recovery possibly stalling out were already priced into the market. But it could be partly because the Fed hasn't had the best track record at predicting these numbers.

In its forecasts of June 2008, seven months after the recession is now known to have begun, the Fed's forecast still projected the economy would avoid a recession, and that the annual unemployment rate would show little change, remaining in the 5% range over the following three years. Instead, it shot up like a rocket, topping out at 10.1% in late 2009 and averaging 9.7% so far this year.

And the Fed hasn't always been so sunny. It has also been too pessimistic at times, which has also drawn criticism.

Based on its own forecasts, the Fed cut its key interest rate to 1% in June 2003, two weeks before the start of one of the best quarters of growth for the U.S. economy in 20 years.

It also left interest rates at that low level for a full year. Many blame those rates for inflating of the housing bubble that would eventually burst and bring about the Great Recession.

"If you look at what actually happened in terms of timing of where we were in the business cycle, monetary policy has a lot of room for improvement," said Lakshman Achuthan, managing director of Economic Cycle Research Institute.

Still, when the Fed speaks, economists listen.

"The Fed is fallible. Still we care what its members think," said Robert Brusca of FAO Economics. "Right now they appear to be getting nervous." To top of page

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