Posted on: Sunday, July 25, 2004

Forecasting economy a bit like shooting craps

By Ken Moritsugu
Knight Ridder News Service

WASHINGTON — The sudden recovery of the U.S. job market this spring caught many economic forecasters off guard and boosted President 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 homebuyers tracking mortgage rates. Companies and investors pay big bucks to get a peek at expert forecasts. 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 comes in.

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

Perhaps most important, economics doesn't revolve around fundamental and immutable laws. Economists are trying to model human behavior, which, 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 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.

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 this 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 in Cambridge, Mass. "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."