If you believe some of the U.S. Federal Reserve (Fed) governors' forecasts, the answer for the Fed's case is a resounding "yes."
Speaking at the Sixth Annual Rocky Mountain Economic Summit in Jackson Hole, Wyoming, last Friday these Fed officers confidently predicted that the U.S. economy would be growing at a rate of more than 3 percent over (an unspecified number of) next quarters. At the same time, they announced that an increase in interest rates was likely to begin in late 2015 or sometime in 2016.
Here is why these forecasts clearly imply that the Fed is already behind the curve.
With an estimate of U.S. economic growth potential somewhere in the range of 2 to 2.25 percent, an actual growth rate of more than 3 percent, sustained over several quarters, would create labor and product market pressures that would lead to accelerating inflation.
Obviously, if such a scenario were to pass, interest rates would begin rising much before the second half of 2015. And, as always in similar situations, the prospect of an open-ended credit tightening would create serious problems in asset markets, without any guarantees of promptly reestablishing market stability and inflation control. That is what is meant by the monetary policy falling behind the curve.
This also clarifies that the furious debate we are now witnessing about the policies conducted by the American and European monetary authorities must be based on thoughtful forecasts about the economic conditions likely to prevail over the next twelve months rather than on what we see at the moment.
That is tough. And to make things even more difficult, this particular forecasting exercise has to contend with additional uncertainties, which are technically called "lags in the effect of monetary policy." In other words, we don't know exactly how long it takes for a change in monetary policy to affect demand, output, employment and inflation. That, too, has to be estimated.
Depressive policy mix
Think, for example, of the fact that virtually zero interest rates in the United States since 2008 are still leaving the economy with an estimated output gap of more than 3 percent – a measure of output waste in an economy operating below its noninflationary growth potential. The euro area economy has a similar output gap, despite its record-low money market rates of 0.2 percent since September 2012.
This evidence contradicts the Nobel Prize winning economic research showing that it takes about four quarters for changes in monetary policy to affect output and prices.
Why that happened will probably be the topic for another Nobel laureate. Meanwhile, here are some of my guesses.
First, I believe that the effectiveness of U.S. and European monetary policies has been greatly impaired by a crisis-induced slowdown of bank lending. The transmission mechanism of the monetary policy got out of order because the weakened banking system was unable, or unwilling, to take the risks of extending credit to businesses and households.
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Second, I also believe that an overly restrictive fiscal policy – especially in the euro area – had largely overwhelmed whatever remained of the monetary stimulus of virtually zero interest rates.
Both problems are still at work.