|March 4, 2007/New York TIMES
The Forecast for the Forecasters Is Dismal
By DANIEL GROSS
LAST week, Alan Greenspan proved that a retired maestro can still seem
to conduct the world's financial orchestra, even if he no longer
occupies the podium.
On Monday, Mr. Greenspan, the former Federal Reserve chairman, said
that "it is possible we can get a recession in the latter months of
2007." His musings, to a group of executives in Hong Kong, were
followed over the next 48 hours by a break in the frothy Chinese
market and poor numbers on United States home sales and durable-goods
orders. Together, the events contributed to a swift downdraft in the
United States stock market, and led to renewed concerns about the
health of the long-running economic expansion.
By Thursday, Mr. Greenspan was backtracking. Noting that while a
recession in 2007 is possible, he elaborated: "I don't think it's
probable." But his comments — and the global reaction — raise a larger
question: If a recession were imminent, would Mr. Greenspan, or any
less august economist, be able to forecast it?
The answer, based on recent experience, is a resounding no. "I don't
think we, as a profession, ever had an ability to forecast
recessions," said Jeffrey A. Frankel, professor of economics at the
Kennedy School of Government at Harvard and a member of the National
Bureau of Economic Research's Business Cycle Dating Committee, the
official arbiter of recessions. "It's hard enough to know when a
recession has started, looking at it with hindsight."
Indeed. No disrespect to Mr. Greenspan, but neither he nor the
similarly numerate members of his professional fraternity have a
particularly good record of forecasting recessions. As Yoram K.
Bauman, an economist who teaches at the University of Washington and
performs stand-up comedy, summed up an often-used line:
"Macroeconomists have successfully predicted nine of the last five
The Economist reported that in March 2001 — the month the last
recession began — 95 percent of American economists believed that
there wouldn't be a recession. In February 2001, the 35 professional
forecasters surveyed by the Federal Reserve Bank of Philadelphia
collectively predicted growth at an annual rate of 2.2 percent for the
second quarter of 2001 and 3.3 percent for the third quarter. It's as
if meteorologists stood outside as the storm clouds approached and
informed television viewers that endless sunshine was ahead.
Economists offer several explanations as to why their fellow dismal
scientists collectively make such lousy forecasters. Nouriel Roubini,
professor of economics at the Stern School of Business at New York
University, believes that there are institutional reasons. Many
forecasters surveyed by the Philadelphia Fed work for Wall Street
investment banks or asset management companies, which tend to argue
that it is always a good time to invest. There are powerful incentives
and pressures not to be unduly bearish about the economy. "When your
firm is bullish on everything else, and is peddling all kinds of
stocks and bonds, nobody will be foolish enough to go the other way,"
he said. Of course, Mr. Roubini is perfectly willing to go the other
way. Last summer, he boldly predicted a recession for the first half
Lakshman Achuthan, managing director at the Economic Cycle Research
Institute, which accurately predicted the 2001 recession, says that
most economists are simply using the wrong tools. "Generally speaking,
professional forecasters tend to extrapolate from existing trends,
albeit in a very sophisticated way," he said.
Doing so, however, inevitably causes them to miss out on inflection
points — at the beginning or the end of recessions, he said. Mr.
Achuthan thinks that the institute's methodology, which focuses on a
series of leading indicators and avoids specific numerical forecasts
about economic growth, allows it to gauge turning points more
The complexity, dynamism and diversity of the United States economy
also make forecasting recessions difficult. In small countries, which
may depend on a single export, like oil, or where a natural disaster
can wreak catastrophic results for the entire economy, it is
comparatively easy to determine when and how one of these factors can
cause a contraction, Mr. Frankel of Harvard said. But in the United
States, whose overall economy has responded so well in recent years to
a series of external shocks — from 9/11 to Hurricane Katrina — it's
rarely sufficient to focus on a single factor.
Christina Romer, professor of economics at the University of
California, Berkeley, says economists can't predict recessions for the
same reason stock market analysts can't accurately predict market
crashes. "Both kinds of events, by their nature, are not predictable
events," she said. Almost all the postwar recessions were preceded by
a shock, like a spike in short-term interest rates, or a sharp rise in
oil prices. "It's impossible to see the shocks coming," Ms. Romer
The very infrequency of recessions in the United States may make it
more challenging to detect their imminent arrival. An entire
generation of economists has grown up believing that the business
cycle is largely something of the past, like black-and-white TV. Since
March 1991, there has been only one recession, which lasted eight
months. It's like asking people who spend their time in Alaska to
start forecasting tropical storms.
AS a group, forecasters certainly don't see a recession coming. On
Feb. 13, those of the Federal Reserve Bank of Philadelphia
collectively raised their estimates for real gross domestic product
growth for 2007 to 2.8 percent, from 2.6 percent.
But just because they've been wrong in the past doesn't mean
forecasters are wrong now. "There is no reason at the moment why the
steady momentum of the economy, with gains in employment feeding back
into consumption growth, should falter," said Robert J. Gordon,
professor of economics at Northwestern University and a member of
Business Cycle Dating Committee at the National Bureau of Economic
To one of the few people who accurately predicted the 2001 recession,
the glass seems half full rather than half empty. "We actually see a
diminishing risk for recession in 2007," Mr. Achuthan of the Economic
Cycle Research Institute said. "Our leading indexes for the vast
service sector have turned up in 2007. This economy is much bigger
than the housing or the manufacturing sector."
Daniel Gross writes the "Moneybox" column for Slate.com.