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August 03, 2010
What makes forecasting tough
Bloomberg's Caroline Baum recounts her recent conversation with the Atlanta Fed's own Mike Bryan under the headline For Good Economic Forecasts, Try Flipping a Coin:
"How do economists fare when it comes to real forecasting, to predicting [gross domestic product] GDP growth and inflation one year out? About as good as a coin toss, according to Bryan's research. Less than half the economists did better than the naive forecast, which is based on no understanding of the economy and merely assumes next year's outcome will be the same as this year's. It's what you'd expect if the results were purely random."
A case in point could be found yesterday on Bloomberg, which featured a "chart of the day" that looked something like the one below (though I've updated the data for manufacturing inventories, given today's factory orders report):
The chart was accompanied by this commentary:
"U.S. business inventories are so low relative to demand that any increase may act as a catalyst for larger companies to add workers, according to Nicholas Colas, chief market strategist at BNY ConvergEx Group."
A few days back, in The Wall Street Journal, you could find this:
"Until recently, businesses had helped supercharge economic growth by restocking inventories. Now the oomph from inventories is waning.
"In the second quarter, the change in private inventories added slightly more than one percentage point to the 2.4% increase in gross domestic product from the first quarter, measured at a seasonally adjusted annual rate, the Commerce Department said Friday.
"That is a big change from the first quarter, when inventory-building contributed 2.6 percentage points to GDP growth of 3.7%, and the fourth quarter of last year, when it contributed 2.8 percentage points to GDP growth of 5%....
"But Friday's report suggests companies are nearly done restocking their shelves.
" 'Our sense is current inventories are about where they need to be globally, both in industrial distribution and with the large North American retailers,' John Lundgren, chief executive of Stanley Black & Decker Inc., said in a July 21 call with analysts discussing the tool and hardware maker's second-quarter results."
But, on the same topic, Seeking Alpha opined:
"Inventory increases added 1.05% to second quarter GDP. Based on the annual revision, they added 2.64% to first quarter GDP or 71% of the total increase. Inventories were also responsible for approximately two-thirds of the GDP increase in the fourth quarter of 2009. The entire economic 'recovery' has essentially been an inventory adjustment [emphasis theirs]. This does not bode well for the future."
So one analysis suggests that the latest readings on inventories portend a boost to GDP, one foresees a drag on GDP, and yet another divines that inventories are basically played out as an economic story for the balance of the year.
Again from the Baum piece:
"Bryan said it's not just about getting the number right. 'It's about the narrative.' "
For comparison, it's also useful to take a longer look at what effect inventories have on GDP growth coming out of a recession; see the graph below. It charts the percentage point contributions of various components to real GDP growth in the first four quarters following the end of a recession (the current recession is assumed to have ended in second quarter of 2009). I've shown on the graph the percentage contribution of inventories to the last seven recoveries, beginning with the one in 1971.
Regarding the point made in Seeking Alpha, inventories have contributed around 70 percent to the economic recovery recently, but in the recovery that began in 2002 inventories contributed 75 percent in the first four quarters. So the last two recovery periods stand out for large inventory components. But looking across the data, it's hard to say what an ordinary inventory contribution would be. Regardless of whether inventories are an unusually large part of this recovery, in absolute levels the scale of the recent inventory cycle—the initial liquidation and the subsequent restocking—has been unprecedented.
By Andrew Flowers, senior economic research analyst in the Atlanta Fed's research department
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