Fed Governor Fred Mishkin laid out part of the intellectual framework for the Fed’s economic uber view.

Because it is so difficult to reliably estimate potential output using either the aggregate or the growth-accounting approach, it should come as no surprise that we at the Federal Reserve use a lot of judgment in constructing our estimates of potential output. In particular, we see judgment as playing three important roles in our procedures. First, it enables us to take account of the effects of structural changes in the economy that cannot be modeled directly. Second, it allows us to deal with model misspecifications that cannot be corrected. Third, we can use judgment to correct for measurement errors or inconsistencies in economic data. For example, we judgmentally adjust model-based estimates of the NAIRU to account for movements in the unemployment rate unrelated to changes in labor market slack. Of these, the most important has been the shift in the demographic composition of the labor force, driven largely by the entrance and subsequent maturation of the baby-boom generation. But economists have pointed to a number of other factors that would influence the NAIRU as well.

If I may translate, I believe that boils down to “we wing it”. And he candidly shatters a Greenspan myth:

…after employment recovered [in the mid 90s], it became clear that the unusual behavior of employment during that period was explained better as a temporary reluctance by firms to hire than as a step-up in the rate of trend productivity growth.

A standard element of Greenspan hagiography is his epiphany on technological productivity explaining unexpected employment patterns.

Good policymaking requires that we acknowledge what we are unsure about…

Kudos to the candid Fed governor.





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