July 26, 2004
BY KEN MORITSUGU
FREE PRESS WASHINGTON STAFF

WASHINGTON -- The sudden recovery of U.S. employment market this spring caught many economic forecasters off guard and boosted President George W. Bush's re-election campaign.

Then the job market slumped in June, again surprising forecasters and delivering fresh ammunition for Democrats to attack Bush's economic policies.

Predicting the economy is a tough game. Everyone wants to know where it's headed, from presidential candidates to home buyers tracking mortgage rates. Companies and investors pay big bucks to get a peek at expert forecasts. It's a huge business. Yet the experts often get it wrong. And they admit their job is a bit of a crapshoot.

"It's one part science, about 10 parts the art of the forecaster and a lot of luck," said Michael Donihue, an economics professor who runs a forecasting model at Colby College in Maine.

Forecasting's poor track record is not for lack of brainpower. Ivy League graduates and Ph.D. economists get paid six-figure salaries to read the economic crystal ball.

But the economy simply won't cooperate.

For starters, economists often don't know what's happening with the economy today, let alone six months down the road. They rely on economic reports, many of which are based on surveys that are at least a month old and often revised in subsequent months as more data come in.

Unforeseen developments, from a terror attack to a rise in oil prices, can derail projections.

Perhaps most important, economics doesn't revolve around fundamental and immutable laws, as do basic sciences such as physics and biology. Economists are trying to model human behavior, which, unlike Sir Isaac Newton's law of gravity, changes.

"Humans are humans," observes Chris Varvares, president of Macroeconomic Advisers, a St. Louis forecasting firm with major automakers, Wall Street firms and several U.S. government agencies as customers. "They don't respond identically to similar situations through time. Their responses are varied, and their behavior is subtle."

Because of the guesswork involved, some university economists disdain the field of forecasting.

"It's like the black sheep of the family," Donihue said. "No one wants to talk about it. No one wants to acknowledge it."

But in the world outside academia, demand for economic soothsaying runs high, from companies figuring out whether to rev up production and hire more workers to Federal Reserve policy makers debating what to do with interest rates.

Guessing probabilities
Ford Motor Co.'s manager of sales analysis, George Pipas, said he uses economic forecasts "to gauge which way the wind is blowing."

At the Fed, officials are wrestling with how much and how quickly to raise interest rates. Their current thinking to lift rates slowly is based on a forecast for mild inflation.

"Their policy is probably the right one, if their forecast is right," said Matthew Rafferty, an economist at the business school at Quinnipiac University in Hamden, Conn. "If they're wrong, the Fed could have an inflation problem six to 12 months down the road."

"The most you can expect" from a forecast, he added, "is not to eliminate uncertainty, just eliminate some of it."

Fed Chairman Alan Greenspan played down inflation fears in congressional testimony last week but warned that "considerable uncertainties remain about . . . the path of inflation."

"You have to treat all forecasts with skepticism," said Nigel Gault, who oversees a well-used forecasting model at Global Insight, a Cambridge, Mass., consulting firm. "Greenspan can say we expect inflation to go down. But no one expected inflation to rise as fast as it did in the first half of the year."

The springtime jump in inflation stemmed in part from one-time factors such as higher oil and food prices. But it's impossible to know just how much to attribute to transitory reasons as opposed to more fundamental ones.

Plenty of lag time
The exact causes of this spring's inflation could become clearer six months from now, Gault said. But the Fed can't wait until then, because it takes six to 18 months for interest rate changes to affect the economy. If inflation is due to tick up next year, the Fed needs to act now to stem it.

Greenspan himself, regarded as perhaps the nation's premier reader of the economic tea leaves, has warned Congress at least twice this year that forecasts are subject to error. "While we can seek to look over the horizon, it doesn't necessarily follow that we can see all that far," he told a congressional panel in April.

"Economists tend to be fairly explicit in making long-term forecasts two, three and four years out," he continued. "We are fortunate in that there is no service out there which collects all these forecasts and reports them back to us two years later. It would be a major embarrassment to most of us forecasters, probably all, if I may put it exactly."

Last month, he prefaced his upbeat economic outlook with the warning that "forecasting even six months out is slightly precarious."

Forecasters, who as recently as mid-May had been predicting a strong April to June quarter, have shaved about a percentage point off their growth estimates since then.

Now, they are busy trying to figure out whether the economic softening is transient or will persist through Election Day.

The answer could determine who occupies the White House next year.

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