Economists state their GNP growth projections to the nearest tenth
of a percentage point to prove they have a sense of humor.
Edgar R. Fiedler
There is always considerable interest in the economic
outlook, and that interest has intensified given the current slowdown.
I am inevitably asked in public settings to provide a short-term forecast
of the economy and, more specifically, to identify the month or quarter
when growth will accelerate. While I sometimes comply, my sense is that
the difficulty of responding to these requests is not generally recognized.
Let me review some recent history, which serves to put
the issue of accurate short-term forecasting in context. In the second
half of 1999, the U.S. economy expanded in excess of 7 percent at an
annual rate, a truly remarkable performance. The rate of growth was
more than twice what the Blue Chip consensus of economic forecasters
had predicted at the onset of the period. Then, in the first half of
2000, the economy grew about 5 percent (annual rate), a rate that again
was about twice what the consensus had predicted. After these positive
surprises, over the past four quarters growth has diminished to just
over 1 percent on average. Although forecasters anticipated a slowing,
the deceleration that has occurred was about twice as bad as the consensus
There is a lesson in these errors, and it is that accurate
near-term forecasting of U.S. economic performance is a difficult, and
ultimately humbling, task. Errors over just the past two years have
been enormous. Neither business economists nor policymakers nor academics
have a distinguished track record.
It is not entirely clear why short-term forecasting remains
so challenging. It may be partly because the economy is buffeted with
shocks that are hard to predict. For instance, it was difficult to foresee
much in advance the spike in energy prices and their subsequent decline.
And it may be partly because the performance of the economy rests on
the moods of producers and investors, and moods can turn on a dime.
It seems like the stock market and business investment went overnight
from an aura of optimism and expansion to one of pessimism and contraction.
As economic circumstances changed, an inventory-correction
process was set in motion. This process has been restraining business
activity, but we do not know how long it will take for inventories to
reach desired levels. The correction process began earlier in some sectors
of the economy than in others, it has proceeded more rapidly in some
sectors than in others, and demand has recovered relatively more quickly
in some sectors, to illustrate just a few of the complexities involved
in analyzing the economy at the moment.
Because of the lags in monetary policythat is, the
time between policy actions and their effects on the economypolicymakers
must give short-term forecasts of the future path of the economy serious
consideration. At the same time, experience teaches that it pays to keep
an open mind about forecasts because they are inevitably erroneous, occasionally
by substantial margins. The limitations of forecasts make it difficult,
other things equal, to pursue preemptive policies and, indeed, it is tempting
to advocate policy caution under almost all circumstances. But excessive
caution could lead to paralysis, an outcome that so far the Federal Reserve
has avoided. Perhaps the saving grace is that monetary policy is inherently
very flexible, and thus we can change our policies, or our minds, as incoming
evidence on the economy helps us estimate the size of our forecast errors.