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If you're anything like us, you may have reached the conclusions that:

  1. Our elected officials are charting a course to a fiscal disaster.
  2. The Fed is repeating past mistakes by setting us up for another bust.

After the drama of the debt ceiling debate and the Fed's non-tapering surprise, we see no reason to doubt these views.

But the latest developments got us thinking, and we have an unusual proposal. Before we share it, we'll need to provide some background.

Recall that the Fed extended and released its economic outlook at its non-tapering meeting in September, and the Congressional Budget Office (CBO) published new projections at about the same time.

The chart below compares GDP growth forecasts from both institutions, including one path per FOMC member for the Fed's outlook (from September's meeting) and a single path for the CBO's outlook (from figures published in May and used in the latest projections):

(click to enlarge)

Apparently, the CBO's Kool-Aid is much stronger than the Fed's. You might even say it's more hallucinogen than sugary fruit drink. Forecasting helpers aside, though, note that the predictions fit perfectly with themes favored by each institution:

CBO: The buoyant growth projection is merely an annual renewal of a long-standing CBO assumption that we'll snap back to normal. It's not so much a forecast but a connect-the-dots exercise of joining today's GDP with a long-run trend line. It also explains the popular claim that there's nothing urgent about our debt problem. By assuming a robust recovery, the CBO bends debt-to-GDP projections downward for the next few years, providing a convenient excuse for inaction. (See here or here for the debt charts and further discussion).

Fed: The unspectacular but unalarming growth forecasts are exactly what you would expect from our monetary policymakers. They're unalarming for the obvious reason - the FOMC can't just say the economy's headed down a sinkhole, at least in public. And they're unspectacular because policymakers have begun to grasp how broken the economy is, even if they don't accept that their own policies helped with the breaking. Also, the tepid forecasts justify policymakers' "whatever it takes" story, preserving both ZIRP and QE.

An intriguing solution

Getting back to our proposal, why not just trade the CBO's economists for the Fed's economists? One group of forecasters moves from the Eccles Building to the Ford House, and the other moves in the opposite direction. That's 2.26 miles according to Mapquest, all in the same taxi zone. Relocation reimbursements would surely be unnecessary.

(click to enlarge)

Think about the policy implications:

  • With a growth outlook matching the Fed's figures above, the CBO's projected debt ratios would no longer bend downward. This wouldn't completely pull the rug out from under the "deficits don't matter" crowd, but it should have some effect. We should at least see a little more urgency on measures to fix our fiscal problems.
  • As for the Fed, the buoyant outlook reported by the CBO's economists would make QE less defensible if not redundant. This should encourage policymakers to follow through on their tapering plan, instead of reprising this year's head fake.

But wait, you say: "Deep down, the CBO doesn't like delivering bad news; and deep down, the Fed doesn't want to taper. You can switch economists, but you can't change outcomes."

We know.

Even if it were plausible, our proposal wouldn't necessarily work, and that doesn't reflect well on the research that shapes public policies.

Which leaves us where?

In all seriousness, CBO and Fed forecasts have been wildly inaccurate, year after year. Evidence shows that these institutions don't understand our economy. Yet, they refuse to migrate from failed methods to more successful ideas. They may claim to be learning from mistakes, but the basic approach is unchanged. You might say they're trying to adjust to the automobile age by strapping wheels to a horse.

Take Austrian business cycle theory, for example. Fair-minded people recognize that recent years' booms and busts were predicted by the Austrian school, even as mainstream macroeconomists were mostly flummoxed. But the mainstreamers refuses to concede that simple truth. Austrian principles are just too far removed from the abstract mathematical modeling that dominates the profession. Acknowledging that real life has proven these principles accurate and the modeling useless would not only devalue resumes but invalidate entire careers.

Unfortunately, much of the establishment considers CBO and Fed pronouncements to be gospel. We know better. The next time you hear someone giving the fiscal "all clear" based on CBO debt projections, pull out the chart above to show what's really behind them. And the next time you hear someone extolling the Fed's expertise, point out that a whole school of economists who actually got things right would disagree.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Source: An Audacious Plan To Fix The QE Non-Taper And Fiscal Non-Action In One Swift Move