Markets and Economy

6 Times Economic First Impressions Were Wrong

At last week’s meeting, the Federal Open Market Committee set lower expectations for the future pace of rate hikes and GDP growth—which many analysts are interpreting as a sign of weakness in the economy. But history shows that first impressions in macroeconomics rarely get it right.


At last week’s meeting, the Federal Open Market Committee set lower expectations for the future pace of rate hikes and GDP growth—which many analysts are interpreting as a sign of weakness in the economy. But history shows that first impressions in macroeconomics rarely get it right.

At its meeting last week, the Federal Open Market Committee set a new median forecast that calls for no additional rate hikes in 2019 and only one quarter-point hike next year. This marks a significant shift from previous forecasts, which called for rates to increase steadily in order to prevent overheating as the labor market tightens.

This pivot shouldn’t come as a surprise. The Fed adopted its data-driven approach to interest rates more than two months ago. With inflation still tame, the decision to leave rates unchanged at the March meeting was widely anticipated. Similarly, changes to the Fed’s balance sheet normalization program have been public knowledge since late February, when Vice Chair for Supervision Randal Quarles expressed the central bank’s intention to stop unwinding its asset holdings later this year. And while the committee’s forecast set lower expectations for the trajectory of interest rates, its new projections only confirm what futures markets have suspected for years.

Many analysts’ initial reaction to the announcement was fear that the slower pace of rate hikes implies that the economic expansion is fading. Instead, the Fed’s pivot last week is more likely a new approach to managing interest rates and inflation than a reflection of concerns about near-term economic risks.

A History of First Impressions

If the market’s first impression of the Fed’s recent pivot turns out to be mistaken, it will join a long list of developments that, despite initial negative reactions, turned out to be benign or even positive for the economy:

  • Unsustainable cyclical deficits: During the recession, the federal deficit swelled to 10 percent of GDP. The contracting economy was producing less tax revenue, so the federal government turned to the bond market to finance emergency stimulus spending measures. The exploding federal deficit inspired dire warnings that this level of borrowing would soon prove unsustainable. In retrospect, the economy had so much slack that bond markets readily absorbed the new issuance. Yields stayed low, and the deficit spending helped stabilize the economy. When growth returned, the deficit shrank to a sustainable 2.5 percent of GDP.  
  • The European Union’s durability: Over the past decade, a series of economic shocks have called the EU’s survival into question. Many economists still believe the monetary union is too large, with too much variance between member states. But a narrow focus on monetary economics overlooks the strong historical forces driving the continent’s unification. Europeans have repeatedly decided to make the sacrifices necessary to maintain their currency bloc, binding the union ever closer.
  • Quantitative easing and inflation: When the Fed began buying up Treasurys in an attempt to drive down long-term borrowing costs, many analysts predicted the asset-purchasing program would create hyperinflation. In retrospect, inflation is driven by aggregate demand, not excess reserves.
  • Quantitative tapering and yields: When the Fed began shrinking its balance sheet, some economists feared that investors would demand higher yields on the larger volume of Treasurys entering the market. The spike in yields never materialized, and a tactical shift—not bond market turbulence—has led to the end of tapering.
  • The oil glut stalls growth: In 2014, cratering energy prices led to worries about the recovery. The shale oil boom had been one of the economy’s brightest spots, and falling energy prices caused immediate cutbacks in capital investment as exploration and drilling came to a halt. But despite being the global leader in oil production, the US is still a net energy importer. The broader economy benefited from lower prices at the pump, and cheap oil likely accelerated growth over the following years.
  • The stimulus of tax relief: The 2017 Tax Cuts and Jobs Act was expected to provide a significant boost to the US economy, speeding up its growth rate over 2018—but in reality, growth last year proved somewhat underwhelming. Recent research by J.P. Morgan economists suggests that much of the spending authorized by the Bipartisan Budget Act of 2018 has yet to materialize, a possible explanation as to why the stimulus didn’t play out as expected. Over the rest of this year, the budget increases may create a meaningful GDP boost.

Time Will Tell

On first impression, the Fed’s newly dovish outlook could appear to imply doubts about the economy. But in time, the pivot might be seen as a sign of confidence in the economy’s ability to hold the high ground. Low unemployment, tame inflation and sustainable growth may mean that interest rates are right where they should be.

View our economic commentary disclaimer.

Jim Glassman, Head Economist, Commercial Banking

Jim Glassman

Jim Glassman, Head Economist, Commercial Banking

Jim Glassman is the Managing Director and Head Economist for Commercial Banking. From regulations and technology to globalization and consumer habits, Jim's insights are used by companies and industries to help them better understand the changing economy and its impact on their businesses.

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