nytimes.com
The New York Times
September 1, 2002
Forecast Too Sunny? Try the Anxious Index
By DAVID LEONHARDT
You almost wonder whether Wall Street's economists were competing with
their colleagues in equity research departments to see who could make worse
predictions.
While the analysts were saying early last year that the stocks of Enron and
the telecommunications sector were undervalued, the economists were
forecasting that the country would escape recession. Whenever bad economic
news emerged, many economists pushed their rosy predictions a few weeks
into the future. Few acknowledged the recession until it was nearly over.
Now the economy is looking weak again, and the forecasters have assured us
that growth is going to pick up soon. Is there any reason to believe them?
Based on history, the answer is no. As a group, Wall Street economists have
failed to predict any of the three recessions in the last 20 years,
according to records kept by the Federal Reserve Bank of Philadelphia.
Hidden in the economists' forecasts, however, is a little-known economic
indicator - call it the Anxious Index - that has been an impressively
reliable warning light for recessions. It deserves to steal some of the
attention from the oft-quoted prognostications of imminent growth.
Predicting shifts in the $10 trillion United States economy is quite
difficult. Economists know that optimism is usually the best bet because
the economy grows more often than it shrinks. "A great many forecasters
forecast the recent past," said Robert Barbera, the chief economist at
Hoenig & Company, a small investment firm in Port Chester, N.Y. "You'll be
right 70 percent of the time," added Mr. Barbera, one of the few economists
to call last year's recession.
The handful of accurate forecasters came almost exclusively from boutique
firms or college campuses, and this is probably not a coincidence. Like
stock analysts, economists at big banks and brokerage firms have a
financial incentive to predict good times. The profits of their companies -
and thus some of their own pay, which can reach seven figures for chief
economists - depend on people's confidence and their willingness to buy
stocks.
Given these conflicts, the steady predictions that the economy will grow by
an annual rate of about 3 percent in coming quarters deserves about the
same consideration as the constant chorus of "buy" recommendations on
stocks.
James E. Cayne, chief executive of Bear Stearns, acknowledged as much while
testifying two years ago during a trial to determine whether the firm
should repay a client who lost millions of dollars based on its poor
currency predictions. Economists "don't really have a good record as far as
predicting the future," Mr. Cayne said. "I think that it is entertainment,"
he said, referring to their work.
That may be a bit harsh. Even if their overall forecasts are unreliable,
some economists at big banks and brokerage firms produce thought-provoking
research about narrower areas like housing and debt. Many might also have a
keener sense of foreboding than they are willing to admit publicly.
Enter the Anxious Index.
In addition to keeping track of the forecasts of economists, the
Philadelphia Fed asks them near the middle of each quarter to estimate the
odds that the economy will shrink over the coming year. The economists give
a percentage for the current quarter and each of the next four.
The magic number for the Anxious Index seems to be 30. When forecasters
think that there is a 30 percent chance that the economy will shrink in the
coming quarter, a downturn usually follows. "When we're up in that range,
it really means a recession could happen at any time," said Dean Croushore,
an economist at the Philadelphia Fed.
(To take a look at the index, type in
phil.frb.org and check under "Mean
Probability of Decline in Real G.D.P." The fifth column from the left
covers the quarter after the survey.)
The index rose above 30 before every recession since 1968, the earliest
date for which the Fed has data. In good times, the index hovers around 10.
It is not perfect. It has sometimes remained above 30 even after recessions
ended and raised a false alarm after the 1987 stock market crash. But the
Anxious Index has a far superior record to economists' actual predictions.
So what does it say these days? After jumping to almost 32 early last year,
shortly before the recession, it remained high until this year's second
quarter, then fell to about 14. It moved to 18 in the most recent survey,
reflecting the summer's weak spending and stock market declines but still
not suggesting that a double-dip recession is likely.
Think of the Anxious Index as a translator for those relentlessly bullish
Wall Street forecasts. Right now, the economists appear to mean what they
are saying. |
