When Forecasts Just Don't Add Up

Look closely at the New Era types whose predictions seem to conflict with their doctrine.
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Exhuming Khrushchev

JACKSON HOLE, Wyo. -- Real

gross domestic product

rose at a 4.5% rate during the first quarter of this year.

Now do three things for me.

    Head to the very first line of Table 1 in the latest GDP release and locate that 4.5% figure (all the way to the right). Scroll down a bit and locate the "Current-dollar measures" section (still in Table 1) and note that Current-dollar GDP rose at a 6.0% rate during the first quarter of this year. Note that Current-dollar GDP is also known as nominal GDP. Scroll down to the very first line of Table 4 and note that the GDP chain-type price index rose 1.4% during the first quarter of this year. Note that the GDP chain-type price index is also known as the GDP deflator.

Cool?

Two notes.

These three numbers illustrate the relationship between a nominal variable and its real counterpart. Specifically, a real variable is nothing more than its nominal counterpart adjusted (by an appropriate price level) for inflation. In this case, real GDP of 4.5% equals nominal GDP of 6.0% less the GDP deflator of 1.4% (blame the rounding on the gubmint stats). As another example, the fed funds rate now stands at 4.75% and the core consumer price index is running at 2.1%, so the real funds rate stands at 2.65%. (When you hear economists talking about "real rates," this is typically what they're talking about.)

For whatever reasons -- going into economics thinking it'd be easier than law, a gross lack of practical training, not being held accountable for poor forecasts, too much theory and not enough real world (especially at those fancy sissy schools) -- lots of economic forecasters just plain suck. But mostly they suck because they just don't think a whole lot about what they're doing. Much in the same way that any idiot can become a parent, any moron can become an economic forecaster. Common sense just ain't a prerequisite.

Your correspondent recently came across two slowdown forecasts that (in his mind, anyway) illustrated this notion. Both forecasts had nominal GDP slowing sharply to a 2.5% to 3.0% rate beginning in the second quarter (the quarter we're in right now) and staying there through the end of the year. One of these forecasts had the GDP deflator sitting at 1.2% come year-end; the other had it dropping to nil.

First the growth part. Take another look back at the nominal GDP growth rates in Table 1 of the GDP release. Note that nominal growth has

averaged

5.5% since the New Era began in (roughly) 1996; note that nominal growth has posted a quarterly increase less than 3.0% only

once

since 1996.

Now ask yourself this: Does a forecast that has nominal growth coming in no higher than 3% during the current quarter and remaining there for two more quarters seem likely to pan out? Why should anyone expect it will? Why, after barreling along at the same robust pace for more than three straight years, would the nominal growth rate suddenly halve? Why would (a) anyone forecast that at all and (b) anyone forecast such a sharp turning point right now? What huge and permanent shock is going to hit suddenly and drive nominal GDP growth sharply lower for the rest of the year?

What? Fear that the world will end on Dec. 31? Well, wouldn't that argue for a consumption binge? The fact that tax refunds have dried up? Well, do they not dry up every year? The fact that people are spending more than they're making? Well, has that not been

happening for two decades? The fact that growth is just plain unsustainable, that the economy will just plain slow on its own? Well, how long until folks rethink the definition of unsustainable? And when in the absence of

Fed

action in the history of U.S. economic cycles has it ever happened that the economy slowed all on its own? When?

Look. Certain forecasters have been calling for a turning point in growth during each and every quarter for the past three years. They keep trotting out the same stale reasons, and they keep proving wrong. Back in December 1997, one of the biggest and smuggest jerks in the profession was screaming about an imminent slowdown (over the following two quarters, consumption soared an average 6.1% and the unemployment rate fell to its lowest level in two decades; to my knowledge, the slowdown never hit). Then, even after that miserable failure, last year he wrote me to point out how stupid I was to keep telling people that economic growth would remain strong. He told me his firm's models were already showing that employment was slowing, and that consumer spending and hence growth at large were sure to follow. And the best part of his argument? If you can even believe this, he wondered how someone who went to

Chico

could think he could compete with someone who went to

Wharton

.

I kid you not.

The point here is not to poke fun at the people who produce forecasts to which your narrator does not subscribe. The point, rather, is to present you with the facts that will shed light on the thinking (or lack thereof) behind those forecasts; that will allow you to make a judgment as to whether those forecasts square with common sense; and that will give you insight as to how a certain segment of the forecasting profession has performed in the past (so that you can decide whether or not you want to listen to what it has to say about the future).

Now the inflation part (recall that there were two different forecasts on this front). Take another look back at the recent performance of the GDP deflator in Table 4. Does it seem to you like that figure is on track to hit zero by the fourth quarter?

It doesn't seem that way to me, but there are lots of bright people who disagree. And if you're one of them, you ought to be loading up on bonds right now. If you believe in a forecast that has growth slowing sharply and inflation falling to zero, then you also have the Fed coming in to lower the funds rate. So you're nuts not to be buying bonds right now. Under that scenario, they're an absolute steal.

How about the slowdown forecast that has the GDP deflator sitting at 1.2% at the end of the year? Does it seem to you that, come December, the deflator will look pretty much like it looks now?

It doesn't seem that way to me, but some people disagree. Not that they make much sense. They believe in the wonders of the New Era, they promise you that

Greenspan

believes in the wonders of the New Era, and they have nominal growth slowing to less than 2% in eight months.

Yet they don't have inflation improving over their forecasts' horizons, which is what New Era doctrine predicts, and even more strange, they are not forecasting a Fed easing under a scenario in which the growth rate falls by two-thirds.

Why is that?

Beware forecasts that just don't add up.

They will bury you.

Side Dish

Best mother?

Lode.

Tongue.

Of pearl.

Hubbard.

Superior.