Fed at Issue
Fed @ Issue
The Exercise of Economic Forecasting
I can usually count on getting a big laugh at this point, which is partly why I do it. But showing how poorly economic forecasts predict the future makes me feel more honest about whatever economic prediction I'm about to lay on the audience.
And here's another humbling observation: Economic forecasts are especially inaccurate when you need them most—around turning points in the business cycle. Forecasting models have a hard time seeing a recession in the making, and—as in the current environment—they have a hard time spotting when recovery will begin.
It’s not a number, it’s a conversation
So our forecast exercise doesn't rely on just one economic model for our forecast; we run a collection of them. Some of the models we use are purely statistical, some are stripped-down economies, and some are large empirical models. None of these models is likely to be "accurate" in that it consistently produces the best prediction. However, taken as a whole, these models provide guidance about a range of possibilities that influence how a Reserve Bank president weighs policy options.
The current conversation
While our forecast shows the recession ending sometime in the third quarter, we see impediments to growth that could cause the economy to bump along the bottom for some time. So while we might soon begin the process of recovery, it might not be a very strong recovery. The key assumptions in this outlook are that financial markets will recover only gradually, consumer spending will remain unusually subdued as households rebuild their savings, and lingering uncertainty about the economy's health will keep a lid on business investment.
There are also a few key issues that are still unfolding and require close monitoring. Perhaps at the top of this list is the state of the real estate market. Has the bottom in home prices been found? How far do home and commercial property prices have yet to fall before they reach a bottom? Another issue is the global economic environment. How sustainable is the recent upturn in the European and Asian economies?
Closely related to these issues is the still fragile state of the financial sector and how financial market dysfunction is likely to prolong the economic recession or weaken a recovery. Atlanta Fed research economists have been working to incorporate financial market dysfunction into a simple dynamic model of the economy.
Clouds amid the clouds
Difficult or not, the process is about to begin again. I can't say at this time how the new forecast will turn out. But there is one thing I can say with perfect certainty: It's going to be an interesting conversation.