January 8 , 2003
This is the time of year when I grade myself on my
forecast for the previous year. Just
over a year ago, I mentioned that the recession was lessening and that
economic growth should slowly build during 2002.
However, we needed to await 2003 before significant growth returned.
Most of that sentiment proved to be correct.
Nevertheless, I can only give myself a high C for forecasting this past
year. That fact that many
economists did even worse does not soften the sting of that assessment.
More than a percentage point of economic growth was
guaranteed as inventory investment shifted from the largest liquidation in
history to modest gains by the end of 2002.
My assumption about low inflation and the creation of more than 2
percentage points of purchasing power was close to the mark.
Also, my assessment that debt would not slow consumer spending because
the cost of debt was falling remains very relevant.
Once again, more than a percentage point of economic
growth could have been expected from this improved purchasing power.
I also expected unemployment to rise through the year,
but my assumption of a 6.5 percent rate by yearend was a little high.
Unfortunately, that level probably will be reached, but later in the
spring of this year.
When you add contributions for government, where my
concerns about state revenues were well founded, then growth of more than 2.5
percent was in the bag.
Then where did I err?
First, I assumed that corporations would have some
pricing power. Although I
correctly assumed that fixed investment would remain weak through the year, I
was hoping for modest profit growth. In
fact, many companies continued to slash prices to preserve market presence.
As a result, balance sheets became shaky and corporate bankruptcies
reached record highs.
Second, I felt that a slowly expanding economy would pick
up steam as job losses subsided. In
fact, job growth never was significant and job losses reappeared before the
end of the year. In fact, except
for the improved purchasing power of consumers, the inventory investment
swing, and government spending (mostly for defense and home security), there
was no driving force to economic expansion.
Instead of building, expansion actually stalled in the fall.
Third, without pricing power, stock prices slumped while
interest rates fell sharply. This
allowed much stronger gains in housing and auto sales than I expected, but did
nothing to aid the financial health of corporations or the credit available to
smaller businesses. Indeed,
corporate officers discovered that it was easier to refinance their houses
than to lower the interest charges on their company's assets.
I am still pondering whether these errors were the result
of underestimating the adjustment to speculative asset excesses or were
another response to poorly timed tax cuts.
Remember, Ronald Reagan slashed taxes over a three year
period beginning in 1981 and witnessed a surge to 10.6 percent unemployed in
1982. When you know your tax
incentives are going to be larger next year, you tend to delay responding to
them this year. A decade long tax
reduction as passed by the Bush administration merely prolongs that agony.
What further dampened the response to the Bush tax cuts
was the early refund of the new 10 percent tax bracket, which actually
diminished tax reductions in 2002.
If the Bush administration wants stronger reactions to its tax cuts, it must bring all those marginal tax rate reductions forward to this year. That will eliminate any muted response to current reductions because they will be larger later.
I also continued to over-estimate the importance of
interest rate changes to enterprises in the short run.
Part of this is caused by the failure of lower interest rates to lower
the finance costs of companies who are struggling to meet sales targets.
In many cases, selling assets and paying down debt is a better strategy
than refinancing corporate loans in an economy where falling interest rates
reflect the absence of pricing power.
However, I finally called the dollar's weakness
correctly. It took several months
and a stock market reversal, but capital began to flow out of the United
States. Surprisingly, this had
minimal impact upon domestic interest rates, probably because of the
deteriorating credit worthiness of U.S.
Indeed, that dollar decline probably will allow U.S.
producers to begin selling goods abroad and stem the flood of goods into the
U.S. If so, and if we get that
acceleration in marginal tax rates, we still might have a good year toward the
end of 2003.
Of course, I must use the current buzz word, geopolitical assumptions, to qualify my assessment. More terrorism or adverse military activity could change everything. Indeed, until corporate balance sheets begin to improve, this economic expansion remains very fragile.