In forecasting, there’s no guarantees

By John Cunniff The Associated Press
Wednesday May 23, 2001

NEW YORK — While the Federal Reserve is receiving high marks for steering the economy through the shoals, barely averting recession, there is no assurance an obstacle might not stray into its path. 

This is another way of saying, as two economists put it, that “the U.S. economy may escape a recession this year, but will not avoid one forever.” Perfect steering is more than can be delivered. 

Contrary to some assumptions over the past year, especially among those who believe the current slowdown is just a rest before another big economic push, the Fed isn’t omnipotent. It’s not in full control. 

You might better understand this when you consider a worst case scenario constructed by economists Cythia Latta and David A. Wyss of DRI-WEFA’s monthly “U.S. Forecast Summary.” 

They expect the expansion to continue, and declare that viewpoint clearly, but they also realize how events can conspire to wreck a forecast. Their description is a credit-course in economics. 

It begins with a misjudgment of oil supply-demand by the Organization of Petroleum Exporting Countries. As the global economy slows, less oil is needed and the price spirals down toward $10 a barrel. 

This sets up a series of Rube Goldberg-like events that, among other things, demonstrates how the world’s economies are linked in a series of pulleys and levers, one event triggering another, nobody in full control. 

While tough on OPEC, the low oil prices give a boost to the global economy, encouraging investors to shift their focus from the United States to other parts of the world. This causes the dollar to slide. 

Because the dollar won’t buy as much, the price of imports rises, which relieves pressure on domestic producers to keep their own prices low and competitive. They too raise prices. 

With the economies of other nations expanding because of the lower oil prices, U.S. exporters find a growing demand abroad for their goods. And because of this added demand, prices of course are likely to rise. 

As you might expect, inflation accelerates. Simultaneously, OPEC seeks to counter the low prices with a drastic cut in production, pushing oil prices back to $35 a barrel. Inflation heads for 4 percent. 

Countering, the Fed tightens up on credit, forcing up the federal funds rate, a basic rate that immediately affects most other rates. By early 2004 it is up to 6.75 percent, compared to just 4 percent now. 

The stock market, already sliding because of the withdrawal of foreign funds and the slowing economy, falls farther. Consumers turn pessimistic as jobs disappear and high interest rates put mortgages out of reach. 

All this causes the housing market to collapse and business investment to decline. The high interest rates slow inflation, but as Latta and Wyss explain, they also bring export growth to a screeching halt. 

By the final months of 2003 the U.S. economy is in recession, and by mid-2004 the jobless rate is 7.7 percent, compared to 4.5 percent now.  

The Fed is forced to quickly reverse course, lowering interest rates. 

The economy recovers, and gross domestic product exceeds 5 percent, about double what it is now, but it must climb up out of the hole it has dug and that takes time. A lot of production and jobs have been lost. 

This grim scenario isn’t likely to come into being. 

No forecast, pleasant or grim, comes with a guarantee. They all come with a caveat. 

John Cunniff is a business analyst for  

The Associated Press