December 28, 2000
As is my tradition, I look back upon what has happened to the economy in the past year, reflect upon how that compared to what I expected, and ask what can be learned from my errors.
A little over a year ago, we were worried about Y2K and the hoarding of goods. I thought the fourth quarter of 1999 would be strong but inventories would be liquidated early in 2000 when the ghosts of global shutdown did not materialize. Then I expected the economy to regain moderate rates of growth.
While I was right about Y2K, I was wrong about almost everything else. The economy did not moderate but boomed. Stock prices did not follow their trend growth rates but soared well above them. Perhaps I should be happy that my forecast of the Standard and Poor's in November 1999 was 1347 for the fourth quarter of this year or that my Dow Jones forecast was 10673.
In reality, those indices will be about 1365 and 10550 respectively for the fall of 2000. I do not know any Wall Street forecasts that were so close to reality nearly fifteen months ago. But I missed the implications of excessive monetary liquidity used to insure the Y2K would not be a headache. And I missed the surge and then plunge in stock market values that would ensue from that liquidity.
I also missed the surge in consumer spending as households spent the riches they thought they had in their stock investments. Although economic theory did not reject the notion that consumers would spend more than they earned, I never thought that would happen. Yet, savings currently is a negative 0.8 percent.
Of course, no one fully understood the problems in energy. I expected oil prices to rise, but only to the low $20s per barrel, not the high $30s before tumbling late in the year. Natural gas prices at $9 per thousand cubic feet were unthinkable just six months ago.
And I just could not believe that the dollar could continue to rebound. Of course, the strong stock market created a great sucking sound as the world's savings came to our financial markets.
Now I understand how the strong economy created a growing budget surplus that allowed the Treasury to buy back bonds. Those bond purchases caused long term government interest rates to fall despite stronger growth, higher inflation, and higher short term interest rates than expected.
I have now learned the importance that government surpluses during times of technological innovation can have upon economic growth. Unfortunately, I do not believe that Larry Lindsay or his protégé George W. Bush have discovered the same truths, but I continue to hope.
Aside from my fourth quarter stock market guesses, I had some successes. I expected inflation to intensify, I expected the trade deficit to deteriorate further, I expected the Federal Reserve to continue raising short term interest rate targets (though by only a percentage point rather than the 1.75 percentage points that actually occurred). My government surpluses were too small, but they were growing in my forecast.
Perhaps I should acknowledge that the "gold rush" fever of the dot.coms occur only rarely. I know, and I believe the Federal Reserve does too, that the flood of monetary liquidity at the end of last year intensified the stock market bubble. Yet, was there an alternative when we were not sure about Y2K?
Certainly, the mopping up of that liquidity should have been done sooner. I still believe the Fed erred in not raising margin requirements last January. Subsequent events strongly suggest that the stock market can be more important to the economy than merely registering its investment health.
We economists continue to learn that we know too little about the supply side of the economy. I expected productivity gains in 2000 to be the same as in 1999. In fact, they are more than a percentage point higher. Some of this is because of higher investment spending, but something more is at work. Even with slower employment growth in the second half of the year, productivity gains remain well above historical rates.
I clearly learned a lot from our miniature bubble economy. The lemming effect dominates market efficiency in the short run but not over time. There is no new economics in evaluating the current value of future earnings that a company can provide. Revenue only matters to the extent that it serves as a stepping stone to understanding future earnings on equity.
Stock markets are more than thermometers. They influence investment and spending and alter the tax collections of governments. Deficits and surpluses matter. I am waiting for an alternative explanation for why long term interest rates declined even as short term interest rates, inflation, and economic growth all rose.
And an economy can always slip on excess liquidity. When the money oil no longer is needed, it must be mopped up quickly, or the economy may soar and then fall hard.
Perhaps I deserve more than a C for learning so much from this year's activity. There certainly was promise in some of my assessments, but too many errors to provide more than an average grade for last year's forecast.