February 23, 1999
A Science Truly Dismal at Prediction
By JONATHAN FUERBRINGER
Want to get an embarrassed smile from any economist these days? Just ask him about his recent forecasts. If he happened to be right on economic growth, the forecast was almost certainly wrong on interest rates. And if a forecast was right on inflation, it was undoubtedly wrong on economic growth.
Forecasting has never been easy and economists in the business have been off base more often than not.
But, still early in 1999, forecasters seem to be setting some kind of benchmark for inaccuracy. For the fourth consecutive year, economic seers have underestimated economic growth so markedly that the rush to revise the original predictions has started almost as soon as the forecasting season has ended.
Why are forecasters so far off the mark? Although questions have been raised for years about the breakdown of traditional relationships in the economy -- such as that between low unemployment and higher inflation -- one reason stands above all others: many economists seem trapped in the model that their education and training drilled into them.
Certainly at this point, late in the long economic upturn that began in early 1991, they have inclinations that make them look not just for higher inflation but for a slowdown as well. Sure, they may eventually get it right, but only in the sense that a stopped clock is right once in a while, too.
"Most of us have been trained to think that when unemployment gets down to this level, you will have inflationary pressures and the economy will slow," said Lyle E. Gramley, consulting economist to the Mortgage Bankers Association and a former Federal Reserve governor.
"If you start with a predisposition that the economy has to slow," he added, "you just have to look for what is going to make it slow down."
In underestimating growth and overstating inflation, economists appear to have made several errors. They played down the impact of technology. They have been baffled by consumer behavior, have struggled to explain the low savings rate and have been left agog at the buoyancy of the stock market.
And they have made what, in hindsight, look like simple misjudgments, such as overestimating the impact of a manufacturing slump and underestimating the positive effects that lower commodity prices have had on consumer spending.
The ever-cautious chairman of the Fed, Alan Greenspan, has contributed to these misinterpretations himself. While Greenspan has long talked about how new technologies may be lifting the potential growth rate of the American economy, he has predicted slowdowns that have not materialized.
Official Fed forecasts, meanwhile, have repeatedly fallen short of actual performance. Greenspan may well be asked about the issue when he presents his outlook for monetary policy and the economy to Congress on Tuesday.
Take Greenspan's comment in September: "It is just not credible that the United States can remain an oasis of prosperity unaffected by a world that is experiencing greatly increased stress." No doubt that encouraged many other smart economists to overestimate the drag that the global financial crisis would have on the American economy.
What is most striking is that most forecasters have still not figured out how to overcome their past mistakes. Economists, for example, remain far from reaching a conclusion on the question of whether the current blend of very strong growth with declining inflation is just a result of temporary factors, such as the plunge in oil prices and the strength of the dollar, or a reflection of more permanent changes.
"It shows you how at sea forecasters are," said James E. Glassman, senior United States economist at the Chase Manhattan Bank. He is one forecaster who has yet to revise upward his forecast of very weak growth in 1999.
Maureen Allyn, chief economist at Scudder Kemper Investments, is more blunt: "I would urge people to pay very little attention to the forecasts they get." She has raised her growth forecast once this year.
From 1996 through 1998, the consensus forecast at the beginning of the year for real growth in the nation's gross domestic product was, on average, 1.4 percentage points below the actual annual growth rate, according to the Blue Chip Economic Indicators. And the consensus estimate for 1999 -- 2.4 percent as of January -- already appears likely to fall short of the mark.
One problem for economists stems from how they approach forecasting. They generally begin by estimating growth and link the rest of the forecast to that. Stronger growth should mean higher inflation and higher interest rates, especially late in an economic cycle when unemployment is low and and industry should be working at close to full capacity.
This relationship has produced one of the paradoxes of the off-the-mark growth forecasts. Those on Wall Street who predicted slow growth last year were dead wrong. But that led them to call for falling inflation and declining interest rates. Bruce Steinberg, chief economist at Merrill Lynch, is one of those who turned out to be pretty close on figures that are more important on Wall Street than economic growth, turned out to be pretty close.
"If I had forecast growth correctly," he acknowledged sheepishly, "I probably would have gotten those other things wrong."
Not that he's not trying again. On Feb. 1, Steinberg raised his growth forecast for 1999 to a 3.4 percent annual rate from a 2.6 percent prediction in mid-December.
Apart from the failure of traditional models, another factor in the frequent pessimism is an outgrowth of practicing the dismal science. "Economists do tend to be gloomy," said Edward Yardeni, chief economist at Deutsche Bank Securities, in accounting for his own miscues as well as those of others.
Several errors have also managed to reinforce one another. While economists agree that an increase in consumers' wealth from a rise in the stock market will help lift spending, there is no agreement on how strong this so-called wealth effect is. The idea is that consumers are willing to spend more of their income when they are feeling good about their investments. But with the savings rate already at or near historic lows going into 1998, it was thought that consumers would start behaving more conservatively. Instead, they were willing to cut their savings rate even lower.
"There was no precedent for the speed or the depth of the slowdown in the savings rate," said John Lipsky, the chief economist at Chase Manhattan Bank.
The stock market's rebound in the fall also surprised most forecasters. "When you are in a marketplace where it is deeply held by the old-timers that the stock market is going to roll over any minute, that deeply affects your thinking," said Stephen S. Roach, chief economist at Morgan Stanley Dean Witter. He has already revised his growth forecast upward twice this year.
Gail D. Fosler, the chief economist at the Conference Board, cites another reason. "You don't lose your job if things turn out better than you forecast," she said. "But you can if they turn out worse."
As it turns out, Ms. Fosler has been more daring -- and more accurate -- than most economists in predicting economic growth. And this year she remains much more optimistic than the consensus, having recently bumped up her 1999 forecast a notch higher, to 3.6 percent.
All this has led Richard Peach, a research vice president at the Federal Reserve Bank of New York, to acknowledge that economic forecasters have even fallen behind weather forecasters in their ability to predict the future. "The meteorologists," he said, "have gone way beyond us."
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