Banking

The U.S. economy should grow at a moderate pace in 2012, but that forecast is subject to considerable risk from Europe, said Atlanta Fed President Dennis Lockhart during a November 29 speech. Lockhart shared his outlook for the upcoming year at a conference hosted by the University of Georgia's Terry School of Business. In addition to modest growth, he expects "decently behaved" inflation and continuing, albeit slow, progress on unemployment.

Europe's sovereign debt problems are not the only threat to the U.S. economic outlook. The nation's own fiscal challenges also pose considerable risk, along with other headwinds such as the weak housing sector and its dampening effect on consumer spending, continued deleveraging by households, and weak credit growth. However, "none of these individually rivals the potential for spillover from adverse developments in Europe," Lockhart noted.

A word on forecasts
In addition to sharing his outlook for the upcoming year, Lockhart also discussed the value of such forecasts—even though they are sometimes wrong. In his view, there are several reasons why economic projections may be off. Forecasters may miss the timing of economic activity, or unexpected developments may change the economy's trajectory.

Also, forecasters may not fully understand how fundamentals are playing out in the economy, a possibility recently illustrated when forecasters debated the expected shape of the economic recovery. Some foresaw a sharp recovery similar to those following past deep recessions. Others, meanwhile, were influenced by the research of economists Carmen Reinhart and Kenneth Rogoff, which suggests that economies are slower to recover from downturns precipitated by severe financial crises. "It is now fairly clear that the Reinhart-Rogoff thesis is the appropriate one," Lockhart said. However, forecast misses are still valuable because they "can lead to a better understanding of those fundamentals," he added.

Forecasts built on "appropriate policy"
Private forecasts and those produced by the Federal Open Market Committee differ in their approach, Lockhart explained. Whereas private forecasters normally base their forecasts on policy assumptions, policymakers start with an outlook "that calls for an appropriate policy posture of either staying the course or making an adjustment."

Lockhart's idea of "appropriate monetary policy" is holding rates at their current level of zero to 25 basis points and keeping the Fed's balance sheet at its current scale. And while he's not taking any policy options off the table, he is "skeptical that further asset purchases will produce much gain in terms of increased economic activity."

December 27, 2011