I have recently been violating one of my cardinal rules: Never forecast the economy. It usually leads to embarrassment. I know this from many humbling mistakes. Yet, my columns have suggested that the glory days of the economic boom may be numbered and that the United States may be headed into–dare I say it?–a recession. Until the last few weeks, when the stock market began to sag, the idea seemed preposterous to most economists. It still does to many.
Consider the latest survey of Blue Chip Economic Indicators, which follows the predictions of 49 economic forecasters. Only one expects a recession starting in 1999. All the rest envision continued expansion. For 1999, the average forecast projects economic growth of 2.2 percent and unemployment of 4.7 percent. That would be impressive for an economy that’s been growing since 1991. I dissent–and not merely to be different.
The reason I avoid forecasts is that, aside from being difficult, they’re typically uninteresting. Although it may matter to General Motors whether vehicle sales total 15.2 million or 14.9 million, it doesn’t matter to most people. But now the outlook does matter: It matters enough to disregard my rule. Asia and much of the developing world face a serious slump. A U.S. recession would deepen the global downturn. The danger, if real, would justify a cut in interest rates by the Federal Reserve. Last week, Fed Chairman Alan Greenspan hinted at just that.
So what are the odds of recession?
Let’s start with the optimistic case against. It goes like this. Both unemployment and inflation are low. Incomes are growing, because more people have jobs and wages are rising faster than prices. Therefore, the economy will expand. And low inflation means that the Federal Reserve won’t raise interest rates to quash price increases; this has been one way recessions have started. In short, the economy’s good and will stay good.
Maybe. The trouble is that forecasts are usually right when the economy isn’t changing much–and wrong when it is. In the early 1970s, forecasters missed inflation’s rapid rise; in the early 1980s, they missed its rapid fall. And they regularly miss recessions.
Failure has many causes. Forecasts have a bias for the status quo, precisely because the economy usually does today what it did yesterday. Herd psychology also reigns. It’s better to be wrong in a crowd than to be wrong alone. Finally, dramatic economic changes often flow from unfamiliar events that forecasters can’t judge from experience.
This is where I think we are now: Two novel shocks menace the economy. The first is the world economic crisis, which started in Asia and is now spreading to Latin America and Russia. Economists have consistently underestimated its severity and, therefore, its likely impact on U.S. trade and employment. Even so, most forecasters predict a huge rise in the trade deficit between 1997 and 1999. The second shock is the drop in the stock market, which–by early September–was approaching 20 percent from its mid-July peak.
Most forecasters doubt this will much dampen Americans’ optimism or spending. Even with the decline, the argument goes, stock prices have run up so much since 1994 (roughly doubling) that most shareholders still feel phenomenally wealthy. They’ll spend freely. I’m skeptical. The so-called “wealth effect” from the stock market caused consumers to lower their savings rate to less than 1 percent of disposable income in early 1998. Most forecasters expect it to stay that low through at least 1999.
By contrast, I think it may go up. Lower stock prices will inspire caution; people will be inclined to buy less and save more. If the savings rate rises to 2 percent or 3 percent (still low historically), consumer spending would weaken. Combine that with a widening trade deficit, and you have a formula for a slump. Business profits and investment would soften; the stock market might drop some more.
The case for the Federal Reserve’s cutting short-term interest rates is to mute this cycle. Lower short-term rates could lead to further declines in mortgage and bond rates. (Technically, the Fed controls only one rate–the Fed Funds rate on overnight loans between banks. It is now 5.5 percent.) This would ease households’ debt burdens, bolstering people’s incomes and spending. Corporate profits and stock prices would similarly benefit. And an easier Fed policy would accommodate a worldwide demand for dollars.
At least I think so. The truth is that everyone’s guessing. We don’t know how consumers will react to lower stock prices, because this bull market has been the biggest since the 1920s. And just how much of an economic tonic lower interest rates would be is always an open question. Still, I think my sober forecast is sensible. But remember this: It could be wrong and, just for the record, I hope it is.
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