| The first of the year brings surveys of economic forecasts, which soon become irresistible targets of journalistic derision. Washington Post columnist Steven Pearlstein just wrote about the "remarkably rosy scenario" of the "economic pundocracy" (though he's a member). On the same day, Robert Samuelson brushed off all the "sunny predictions" and offered a variation of Pearlstein's shopping list of things that might go wrong. The dollar might crash, for example, which they almost certainly said last year. Or we might be hit by a comet. In my capacity as an economic journalist, I too have often succumbed to the temptation to make fun of forecasters. The difference is that I actually was a forecaster for many years. In the late '70s, I found myself on a panel in Chicago at the American Economics Association with Bob Eggert, who founded Blue Chip Economic Indicators in 1976. I remarked that economic forecasts were an excellent lagging indicator of where the economy has been. That resulted in me being recruited to join the Blue Chip forecasters for many years, until it dawned on me that Eggert was getting the last laugh on forecasters by selling our work and not paying us even the minimum wage. Since forecasting paid nothing, I rarely spent more than a few hours on it. Yet, I nonetheless continued to contribute to the Wall Street Journal survey from 1986 to 2000 as a hobby -- a sport similar to target practice. I was understandably nervous when, in 2002, the Federal Reserve Bank of Atlanta published a potentially embarrassing study --"Evaluating Wall Street Journal Survey Forecasters." Larry Kudlow came in with an extraordinarily accurate score of 74.9, compared with mine of 65. We are old friends who worked together on the OMB transition team in 1981. As the study notes, however, "the people with the superior performance record tend to be those whose forecasts covered a short period of time." The longer the records are kept, the greater the risk of being caught stumbling over surprises. The highest score went to someone who had participated in only five surveys after the 1991 recession, the second highest made six forecasts. By contrast, Kudlow had accumulated 11 forecasts, while I had 27 under my belt -- including two recessions. Among those with as dangerously long a forecasting record as I had, the two with a higher score were someone named Hoffman (67.7) and someone I knew -- David Resler of Nomura Securities (67.8) -- because we had worked together at the First National Bank of Chicago. Forecasts tend to cluster close together, because it's risky to go out on a limb -- as I did on Jan. 1, 2001 with my sunny forecast that "we are precariously close to recession, or already in one." We are not always sunny or rosy. The expert judgment of 56 economic forecasters in The Wall Street Journal is not something that can be brushed off that easily. This year depends on the forecasters being right about inflation, and I think they are. What happens to inflation should affect the one risk that Pearlstein, Samuelson and I agree is real -- namely, that the Fed might push the fed funds rate significantly above the yield on 10-year bonds, thus inverting the yield curve. Wall Street Journal inflation forecasts are for the 12 months ending in May. The 56 forecasters expect the consumer price index (CPI) to be up by 3.1 percent between May 2005 and May 2006. But they already know what inflation was for six of those 12 months -- namely 3.8 percent (half of which was energy). To get that 12-month average down from 3.8 to 3.1 percent by May, inflation will have to average just 2.4 percent from December to May . Nearly half the forecasters expect it to be even lower. Is that unrealistic? I don't think so. Aside from energy, which is last year's story, the CPI rose at only a 1.9 percent rate over the past six months. The odds of energy prices rising much further from today's high level are near zero. Even if energy remained as expensive as it is, that would add nothing to future inflation. To get overall inflation up to 2.4 percent would therefore require much faster price hikes for everything except energy. I keep reading that the Fed worries that last year's energy price spike will spill over into this year's nonenergy prices. Yet, that has never happened. Never. Continued... |