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October 21, 2011
Is the growth tide turning?
It has been a tough year for forecasters, as the Atlanta Fed's President Dennis Lockhart explained in a speech delivered Tuesday evening:
"The basic story of the first half of this year was one of disappointment versus expectations. At the beginning of the year, the consensus forecast had gross domestic product (GDP) growth for 2011 in the range of 3 to 4 percent. Though the Atlanta Fed's forecast was at the lower end of that range, we generally shared the view that the recovery was firmly established…
"A pretty clear picture of just how bad the first quarter was became apparent toward the end of the second quarter, when the FOMC met in late June. At that point, notwithstanding weakness in the early months of the year, the widely held outlook was that growth would rebound in the second half. Many anticipated that the effects of the price and disaster shocks would quickly dissipate…
"As the summer progressed, the data surprises were unrelenting and on the negative side of expectations.
By the time of the early August FOMC meeting it was clear to my Atlanta Fed colleagues and me that we had to rethink our position. The momentum of the economy looked a lot weaker than was our assessment earlier in the summer."
That story is well-captured by a picture of the evolution of Blue Chip consensus forecasts over the course of the year:
As President Lockhart explains, what has been most worrisome is the cumulative nature of the forecast errors implied in the above chart:
"Let me mention parenthetically that, given the complexity and dynamism of the economy, forecasting is fraught with errors and misses. One of my colleagues says the only thing he can forecast with certainty is that his forecast will be wrong. It's when forecasts are persistently wrong in the same direction, and by a substantial measure, that you worry you've missed the real story."
That reality can, of course, work in a positive direction as well as a negative direction. The encouraging news is that the forecasting mistakes have been accumulating in the direction of excess pessimism:
"We at the Atlanta Fed regularly monitor the data series that directly enter into the GDP calculation, along with important other series, including employment… In the months leading up to July, the downside surprises in the data dominated. In August and September, upside and downside surprises were roughly equal. But in October, the surprises have generally been to the upside."
One aspect of this analysis is called a "nowcasting" exercise that generates quarterly GDP estimates in real time. The technical details of this exercise are described here, but the idea is fairly simple. We use incoming data on 100-plus economic series to forecast 17 components of GDP for the current quarter. Those forecasts of GDP components are then aggregated to get a current-quarter estimate of overall GDP growth.
The outcomes of this exercise have been as positive in the third quarter as they were negative for the first two quarters of the year:
At this point, we'll interrupt this blog post to offer a few disclaimers. First, we wouldn't want to put too much weight on the specific number cranked out by this exercise. Also, beyond the usual warnings about the imprecision of statistical estimates, we'll add that much of the data being used in the estimates are subject to revision—and we don't yet have very much information on activity in October. Finally, even with the improvements in performance versus expectations, the view of the moment is still centered on near-term growth that is less than stellar, as President Lockhart described in his remarks:
"[M]ost private sector forecasters envision growth in 2012 approaching 2.5 percent. In the opinion of many economists, that 2.5 percent approximates the steady-state growth rate of the economy's potential. This rate would certainly be an improvement over 2011 as a whole. The problem is without growth measurably better than 2.5 percent, little progress will be made in absorbing slack in the economy—above all, labor market slack."
But after the long run of negative news that has characterized most of this year, we are for now at least moving in the right direction.
By Dave Altig, senior vice president and research director at the Atlanta Fed
Patrick Higgins, economist at the Atlanta Fed
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