OCTOBER 5, 2000
COMMENTARY
By Michael J. Mandel
Forget Those Rosy Economic Forecasts | The prognosticators are notoriously off-target, and today's New Economy is truly uncharted territory for the models they're still using
| As the economy heads into the fourth quarter, signs of a slowdown are appearing everywhere. The index of manufacturing activity from the National Association of Purchasing Management has fallen below 50 in September for the second month in a row, suggesting manufacturing is contracting. And new orders for capital goods, outside of defense and aircraft, are also heading down, signaling a possible pause in the investment boom.
Yet most forecasters are still predicting solid growth for the next couple of years, with no recession in sight. For example, Macroeconomic Advisers, a well-respected St. Louis-based forecasting firm, expects that after a slow third quarter, the economy will return to a roughly 3.5% growth rate well into 2002. Indeed, they see an almost perfect economic environment: A roughly 4% unemployment rate, little acceleration of inflation, and no need for the Federal Reserve to raise interest rates.
How much faith should we put in such a rosy scenario? The short answer is: Not much. Forecasters have a terrible track record when it comes to predicting downturns. In fact, the economic forecasting community has completely missed the last three recessions.
EXACT OPPOSITE. Consider the economic prognostications that were made just a few months before the last recession started in July, 1990. The consensus of forecasters in December, 1989, according to a Business Week survey done at the time, was that economic growth in 1990 was going to gradually accelerate over the course of the year, hitting 2.5% in the second half. Instead, the pattern was the exact opposite. The economy started off 1990 strong, weakened in the second quarter, and then fell into recession in the second half after the Iraqi invasion of Kuwait.
What's worse, even after a recession starts, forecasters generally have underestimated how long and deep it would be. Take the recession that began in July, 1981. Most forecasters were convinced that it was going to be short-lived, so when they were asked in December, 1981, for their predictions for 1982, the consensus outlook was for 2.9% growth. The reality: The downturn got more and more damaging, and the economy actually dropped by 1.7% (these numbers are based on the version of the government's economic data issued in 1982).
The prediction problems this time are likely to be even worse, since forecasters are using Old Economy models to predict a New Economy future. In particular, their models for tech prices and spending have been completely off. Moreover, there's no real understanding of the importance of the financial market in spurring innovation and productivity growth.
It's certainly possible that the Federal Reserve has achieved the long elusive soft landing and that the economy will indeed grow at a steady rate without higher inflation. But based on history, investors and companies worried about a possible recession would do better consulting a Ouija board than relying on the sunny predictions of economic forecasters.
Business Week Economics Editor Mandel is the author of The Coming Internet Depression
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Copyright 2000, by The McGraw-Hill Companies Inc. All rights reserved.
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