January 5, 2005
At this time of year, I traditionally review my outlook
from the previous year to determine how well I understood economic
conditions and to see if I can learn something from my forecast errors. Under normal circumstances, my forecast performance was
worthy of a high B.
But there was nothing normal at the beginning of last
year. Venezuela oil production
had collapsed from strikes that were to go on for another two months.
North Korea was threatening to use nuclear power to force the U.S. to
the bargaining table. And we were turning up the heat on Saddam Hussein in Iraq.
Under such circumstances, I believe it is only fair to
give me a low A for my forecasting efforts.
In doing this analysis, I am using comments from my
mid-January outlook column as well as the monthly forecasts I post on a
At the beginning of the year, I was confronting the
reality of lost momentum in economic growth, a backslide in employment (we
lost another 800,000 jobs before new hiring finally returned in late
summer), and further uncertainty in tax policy.
I expected jobs and corporate spending to begin growing
by summer, and they did. While
I expected economic growth to be sluggish in the first half of the year,
about 2 percent, I saw growth reaching 4 percent before year end.
I knew that Federal Reserve activity and tax policy
were unusually stimulative. For
this recovery to collapse with so much policy thrust would almost deny my
understanding of macroeconomics. Indeed,
my forecast was lower than what I thought that thrust could produce.
My failure to fully accept my economic understanding was the greatest
failure of my forecast.
In fact, the 2 percent first half growth was only
slightly too conservative. Of
course, we zoomed past 4 percent in the summer and should stay above 4
percent this fall.
Because of Venezuela's oil problems, I saw inflation
surging in the winter but then subsiding during the summer to less than 2
percent. In fact, prices did
surge and then fall. In
November, consumer prices were only 1.8 percent above previous year levels.
I suggested that the Federal Reserve might even
"lower rates" in the winter.
They did so in the spring and then held 1 percent for federal funds
rates for the remainder of the
I expected ten year government bonds to yield about 4
percent all year. In fact,
deflationary concerns pushed rates down to nearly 3 percent in June.
By the end of the year, however, yields are slightly over 4.1
I think I should be excused for not seeing the
deflationary flash before reasoned thinking restored more appropriate yields
to long term rates. I mentioned
that mortgages would continue to fall, which certainly occurred until
I took a lot of criticism for suggesting that the stock
market already was in a rising channel as the year began.
In fact, the October lows were tested but held in March, and then the
bull market surged in earnest. By
the end of the year I was looking for a "sustained rally to challenge
10,000….late in the fall."
As far as stock market forecasting is concerned, that
is a direct hit. I hope my
readers saw as much improvement in their investments as I did this past
less than I expected, but my use of the word "anemic" for wage
increases captured reality.
Unemployment only reached 6.3 percent before subsiding
(I expected 6.5 percent), but I again captured the essence of labor market
Consumers spent more robustly than I expected and the
savings rate was lower. I
worried about auto markets being satiated.
That worry materialized in the fall, but not as dramatically as I
While I certainly did not paint a perfect picture of
the 2003 economy, I certainly had all the correct outlines, and some of the
detail was remarkably close.
So what did I learn?
First, even if corporations tell you they do not see improvement, use
your training and trust economic theory.
Theory certainly did not fail me this time.
Second, unless "geopolitical" issues directly
impact economic conditions such as oil supplies or trade deficits, their
impact upon the economy is fleeting. Economic
behavior is more robust than most people want to believe.
And I still am a pretty good forecaster. So let me enjoy my low A, even if there were a few rough spots when you look more closely at the 2003 forecasting portrait.