Research

The economic forecast? Cloudy with a chance of showers, at least until 2010

A year ago, economists were talking of a possible recession, but few predicted the severity of the present financial crisis. Possibly to compensate for their failure to foresee the wide-ranging repercussions of the housing crash, they're examining their models daily and forecasting years of doom and gloom ahead. But looking beyond the models, prominent economist Dr. Joel L. Naroff, President of Naroff Economic Advisors, is a little bit more optimistic than most forecasters about 2009. Naroff delivered his 2009 economic forecast at a recent reception in New York where he received the 2008 Lawrence R. Klein Award for Blue Chip Forecast Accuracy.

2008-11-19

A year ago, economists were talking of a possible recession, but few predicted the severity of the present financial crisis. Possibly to compensate for their failure to foresee the wide-ranging repercussions of the housing crash, they're examining their models daily and forecasting years of doom and gloom ahead. But looking beyond the models, prominent economist Dr. Joel L. Naroff, President of Naroff Economic Advisors, is a little bit more optimistic than most forecasters about 2009.

Naroff delivered his 2009 economic forecast at a recent reception in New York where he received the 2008 Lawrence R. Klein Award for Blue Chip Forecast Accuracy. The award, which is sponsored and judged by the W. P. Carey School of Business and is highly regarded in the field, recognizes the economist who has compiled the most consistently accurate economic predictions over the preceding four-year period.

But the events of 2008 have taken Naroff by surprise. "I certainly didn't see it coming," he said. The year defied trends in the key economic indicators to become, according to Naroff, "probably one of the more difficult if not dangerous times we've seen in close to 80 years."

"There are circumstances in which forecasting requires as much art as it does science, and this is one of them," he said. "Understanding the numbers is simply not enough, especially as we try to deal with economic models that tell us vastly different things on a weekly, monthly, and quarterly basis."

According to him, the key to successful predictions in times of rapid change is to first understand the circumstances surrounding those changes.

The recessions of the 1950s and '60s were manufacturing inventory recessions. "Those were relatively easy to forecast because we knew that once all the excess inventories were worked off, the manufacturers would get back to work, they'd start hiring people again, and the economy would get back up," said Naroff.

Naroff maintains it was likewise apparent to economists in the seventies that their recession was the product of a Federal Reserve board so terrified of inflation that it stifled the economy with high interest rates. "Once they decided it was time to take their foot off the economy's throat and started lowering rates, the cycle turned back around," he said.

Reminiscent of the Great Depression?

The current crisis, however, is much trickier to assess from Naroff's point of view because it has spread from the housing market crash where it started to so many other sectors -- most importantly, to the financial sector, which hadn't seen a serious setback since the dotcom bubble burst in 2001. This time, however, the imaginary money was not in the hands of tee-shirt-wearing twenty-somethings in Silicon Valley, but deep inside the pockets of the financial sector itself, mostly in the form of make-believe financial assets.

In that sense the crisis is reminiscent of the Great Depression. "The difference that sets this crisis apart from the Depression of the '30s is that we have the Depression of the '30s -- we lived through it, we learned all of those lessons," said Naroff.

Naroff attributes the rapid changes of the last six months to widespread fear. "An awful lot of fear and uncertainty has gripped individuals and businesspeople. When we had a 5.5 or even a 6 percent unemployment rate -- rates that historically are not particularly high -- businesses weren't investing and households had stopped spending. They were behaving as if we had already gone into a steep recession."

And it's the gradual replacement of that fear and uncertainty with confidence that will ultimately determine when the economy makes its recovery. According to Naroff, at some point in the coming year, "people are going to wake up and say, hey, I still have a job, I still have income, I think I'm getting through this now, why am I behaving this way?"

When exactly this change in mindset occurs will be determined by the success of the Fed's bailout and the renewed availability of credit. Regardless, Naroff maintains that the change will occur faster than the current models predict. "We have a trigger for recovery, and that trigger could be sharper and sooner than most people have forecast," he said.

Will the model break?

Even though Naroff is optimistic, he is quick to point out that the outlook is not good. The stock market is in tatters, consumer confidence levels are at an all-time low, credit restrictions have become draconian, unemployment is the highest it's been since March 2004 and will most likely continue to rise, and the government has taken the economic helm.

Naroff's models paint a bleak picture of the next six months: "Growth can decline 3.5 to 4 percent. And even once we start coming out of it, the growth will probably be slow almost as far as the eye can see -- at least through 2009."

But according Naroff, this may not be the case. "The models may have it right in the short term, but may not get it right as we move through 2009, especially as we move through the second half of 2009," he said. "I'm expecting the second half of 2009 to be better, and indeed, going out on a limb, that the fourth quarter of 2009, if that switch flips, could be incredibly strong."

The new liquidity that results from the Treasury's fiscal and monetary policies could hasten the requisite return of consumer confidence. The Fed has dropped its lending rate to 1 percent. According to Naroff, this is largely a PR move to further inspire confidence. "Rates aren't the problem; the problem right now is the willingness and the ability to make loans. If they lower rates again they're basically saying, 'we're with you.' So they could drop again, but either way, I don't think it really matters."

The current crisis is being blamed partly on Alan Greenspan's failure to temper the stimulus his low interest rates provided the economy, so the Fed will naturally start worrying about inflation once the economy begins to turn around. Naroff predicts the Fed will raise interest rates extremely quickly. "I wouldn't be surprised to see the Fed's funds rate rise from 1 or 0.5 percent to 4 to 4.5 percent in a six-month period. It'll be sharp, it'll be rapid because it wants to make sure that once the economy is out of danger it doesn't create the next bubble."

Naroff is confident that the bailout will have its desired effect and that even a gradual recovery will have a marked impact on people's mindset that will further accelerate an economic turnaround.

"You can actually create a lot of growth by going from what's really terrible to something that's mediocre," he said.

Bottom Line:

• Financial models are predicting a grim 2009: 8 percent or more unemployment, negative growth at least through the first quarter if not into the second quarter, and weak growth through the second half, but they don't take into account the nature of the crisis.
• Dr. Joel L. Naroff believes that once the government's bailout package takes effect, people realize they are going to make it through the crisis, and normal lending standards are reestablished, consumer confidence will return, resulting in a much stronger final quarter of 2009 and first quarter of 2010 than the models currently predict.
• Despite his optimism, Dr. Naroff agrees with forecasts of rising unemployment and negative 3 to 4 percent growth through the first half of 2009. He believes the Fed may drop its lending rate to below 1 percent but will raise it (as high as 4.5) within six months of the first signs of economic recovery.

Economics