Disappointing recovery, not much growth in sight

Goldman Sachs chief economist Jan Hatzius received the W. P. Carey School’s 2011 Lawrence R. Klein Award for Blue Chip Forecast Accuracy in a ceremony on October 20, 2011. The award, presented this year by former Secretary of the Treasury Lawrence Summers, recognizes Hatzius as the most accurate forecaster among the 50 economists who submit forecasts in four categories annually to the Blue Chip Economic Indicators. At the ceremony, Hatzius offered insight on what the economy faces in 2012.

Delivering accurate and consistent economic forecasts is a difficult task in even the most benign of economic climates. In the economic slump, we currently find ourselves enduring—marked by a stubbornly stalled recovery from the global financial crisis, as well ongoing effects from the credit crunch, the housing bust, rising unemployment levels, and plummeting interest rates—offering an accurate and consistent economic forecast is nearly impossible.

But Jan Hatzius, chief economist for Goldman Sachs, tackled that nearly impossible feat with aplomb, and for his efforts received the W. P. Carey School’s annual Lawrence R. Klein Award for Blue Chip Forecast Accuracy on Thursday night at a ceremony in New York City, hosted by the W. P. Carey School of Business at Arizona State University. Having also won the award in 2009, Hatzius becomes one of only three individual forecasters who have won the award twice in the past 30 years of competition.

The prestigious award was named after Nobel Laureate economist Lawrence J. Klein, who was credited as “the pioneer of economic forecasting” by the evening’s moderator, Randall Moore, editor of the Blue Chip Economic Indicators. The presenter was Harvard University professor Lawrence Summers, Secretary of the Treasury under President Bill Clinton and director of the United States National Economic Council for President Barack Obama.

As the winner, Hatzius bested 50 other economists who submit forecasts in four key indicators (gross domestic product (GDP), consumer price index (CPI), unemployment, and the Treasury bill rate) each January in the Blue Chip Economic Indicators newsletter. Hatzius, who previously has been honored by The Wall Street Journal and Institutional Investor as the top economic forecaster in the nation, had the most accurate economic forecast among Blue Chip survey participants for the years 2007, 2008, 2009, and 2010.

Hatzius, who joked that he and his team at Goldman Sachs were “just a little less wrong than other economic forecasters over the last few years,” maintained an impressive forecasting record, with a four-year overall average percentage error rate of .713. His four-year average percentage error rates for the individual categories tracked by the Blue Chip newsletter were: GDP, 1.225; CPI, .600; Treasury bill rate, .425; and unemployment rate, .600.

What Lies Ahead for 2012

Unfortunately, given the accuracy of Hatzius’ track record, his team’s outlook for 2012 doesn’t bring much reason to be optimistic about next year’s economy. “In a nutshell, we predict continuing low growth, low inflation, and low interest rates,” said Andrew Tilton, a Goldman Sachs economist who joined Hatzius in presenting the team’s forecast. The forecast, Tilton noted, was not much different from one they offered when Hatzius won the Klein award in 2009 -- evidence of the disappointing speed of recovery since the official end of the recession.

For 2012, Hatzius and the Goldman Sachs team forecast a below-trend growth rate of roughly two percent, which Tilton noted, “will not be enough to reduce a large number of unemployed and underemployed” in the United States. The current unemployment rate, hovering at around nine percent, will increase slightly to 9.4 percent, Hatzius predicts.

And, as Tilton indicated, the unemployment rate tells only half the story. For the full effect, one must take all four categories of unemployed workers into consideration. The long-term unemployed, who have been out of work for more than six months, currently account for four percent of the labor force -- a number greater than at any time in the last 50 years. The other three groups include the short-term unemployed, the marginally attached (who are out-of-work but not actively seeking employment), and part-time workers who want full-time work. Together, this group accounts for 16 percent of the labor force.

“Basically, one in six Americans is working less than they want to be working. And, without stronger growth, this fact isn’t going to change significantly in 2012,” Tilton explained.

The amount of long-term unemployed workers is particularly concerning for the nation, Hatzius explained, because high unemployment sustained for a long period of time raises the risk that workers will lose their skills and their attachment to the labor force and ultimately become unemployable.

At the same time, growth is being hindered by the pullback in government spending at local, state, and federal levels. “We are entering a period of fiscal austerity in government policy. [The decline in government fiscal spending] is gradual, but will nonetheless have a meaningful impact on economic growth,” Tilton said. The team predicted that government fiscal policy will likely subtract about one point from economic growth in 2011, with a similar result in 2012.

As a result, Tilton noted, any strong growth for recovery will have to come in large part from the domestic private sector, which also faces a less-than-rosy financial picture for the immediate future. Don’t expect to see a surging private sector recovery, Tilton cautioned. “There are reasons to doubt the strength of such a recovery because many of our large trading partners are struggling with their own problems,” he explained. “In particular, the impact of the financial turmoil in Europe is having a significant effect on financial and credit conditions in the United States.”

One positive note is that the Goldman Sachs team does not expect inflation to be a concern for the immediate future. Core inflation rates are resting comfortably in the two-percent range and are unlikely to rise. “In an environment where demand is very weak and unemployment is high, we do not expect inflation to be a significant economic concern over the next couple of years,” Tilton noted.

Lessons Learned—And What They Could Mean

For Hatzius and his team, a large part of preparing an accurate economic forecast is looking back to lessons learned, of which there were many during the last tumultuous four years. “A depressing period of the economy is an instructive period for economists,” quipped Hatzius, outlining three key lessons that his team and other economic forecasters learned, or should have learned, since 2007.

The central insight around the origins of the financial crisis and why our economy has been so devastated, Hatzius said, can be traced back to the theories of American economist Hyman Minsky, who coined the expression that “stability can be destabilizing.” The low volatility and flush times experienced by the American economy in the 1990s and early 2000s brought about higher corporate profits, greater stock market valuations, a strong labor market, and low inflation, but as a result, the economy grew so large that it became vulnerable to even small negative shocks, Hatzius explained. “The initial great stability of the economy has proved quite destabilizing in the longer term, and the resulting downturn has proven deep and difficult to reverse,” he said.

Part of what has made the downturn so immune to reversal is the fact that both
fiscal stimulus—in the form of increased government spending and higher tax cuts—and monetary stimulus—achieved when the Federal Reserve Bank alters reserve ratios and/or lowers discount rates—are typically undersupplied after crises, Hatzius added, providing lessons number two and three. Addressing the fiscal stimulus side, Hatzius referenced a quote from presenter Lawrence Summers: “The central irony of this crisis is that while it was caused by too much confidence, borrowing and spending, it is only resolved by increases in confidence, borrowing and spending.”

However, as Hatzius and his team have predicted, fiscal stimulus—which has been in short supply at all levels of government since the 2009 federal stimulus package, the American Recovery and Reinvestment Act, was put in place—is not likely to be a continuing source of confidence, borrowing, or spending any time soon. “After a period in which fiscal stimulus has already been applied and the economy is still in bad shape, it is all-too-tempting to believe that government deficits are part of the problem rather than part of the solution,” Hatzius said. The downward drag that tightening fiscal policy will likely have on our still-fragile economy is a large concern, he added, and one he expects to continue “for the foreseeable future.”

“Just as fiscal stimulus is undersupplied relative to the amount that is needed, monetary stimulus is also undersupplied in a national crisis,” Hatzius added. While interest rates were slashed to nearly zero in 2008 and remain at historic lows, monetary policy has not been able to counteract the power of the downturn. As evidence of the downturn’s unfortunate staying power, Hatzius pointed to the path of the country’s nominal GDP before and after the crisis. “Even three years after the crisis, nominal GDP is still about 10 percent below the pre-crisis spend,” he explained.

A Possible ‘Target’ for Improvement?

So what can be done to counteract the current lack of monetary stimulus? Hatzius and the Goldman Sachs team believe the Fed has the power to enact one option that could be a powerful jumpstart. “One promising option is for the Fed to focus more directly on the level of nominal demand in the economy. Specifically, we think the Fed is capable of targeting a level of nominal GDP,” Hatzius explained, adding that the bank should commit to using more asset purchases to achieve that goal. “We think more monetary easing is warranted and likely—and we expect the Fed to do that by expanding their balance sheet further in 2012,” he noted.

But targeting a path for a nominal GDP is a big step for the Fed, and one that Hatzius does not include as part of his forecast for 2012, although he notes that the strategy would be “consistent with the Fed’s dual employment and price stability mandates.” He put the probability of the Fed publishing a nominal GPD target level within the next year or so at well below 50 percent, but noted that the Fed will likely “move in the direction of putting a bit more weight on the employment target part of the mandate, and indicating that they are willing to keep monetary policy easy until the unemployment rate has fallen by a certain amount.”

Hatzius also cited his belief that this action by the Fed could lend some credence to the central role that confidence needs to play in the economic recovery. While confidence is bandied about as a key factor for economic improvement, its unclear definition leaves many wondering how to spur it. “There is a lot of talk about the central role of confidence in economic recovery, but it is always a little difficult to know what confidence is exactly, how we can measure it, and what policy makers can do to improve it,” Hatzius explained. “We think that a move in the direction of nominal income targeting might help by stabilizing and coordinating expectations for economic recovery. It would make the notion of confidence in economic recovery a little more concrete.”

Given his position as a two-time Klein award recipient, there is certainly confidence in the accuracy of Hatzius’ forecast—even though the predictions it contains may not inspire confidence in an economic recovery anytime soon.