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Warning flags flutter on economy

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Economists are reluctant to forecast recessions, especially since they have become less frequent in recent years. It is professionally damaging to wrongly predict such a slump.

Economists are less reluctant to warn of trouble ahead, such as a housing bubble bursting, trillions of dollars in loan-related financial packages coming unglued, or the dollar plunging as huge United States trade deficits continue.

In general, economists do modestly better at predicting the economy than simple mathematical projections of past economic trends do. But economists often get into trouble when they try to foretell financial downturns.

Perhaps that's why most economists are cheery about the health of the US economy.

Economists and policymakers at the US Federal Reserve also have a history of upbeat forecasting. They didn't see the last recession in 2000 and 2001 until about nine months after it started.

That's typical, because the Fed and other economists rely on financial data collected with a lag of a month or more.

"It is like driving down the road with your eyes glued to the rearview mirror," says Harald Malmgren, a Washington consulting economist. "When a bend in the road comes, this navigational technique is unreliable."

Many stock-market investors are aware of this risk. Late last month, the Fed raised short-term interest rates one-quarter of 1 percent for the 15th time since June 2004, to 4.75 percent. With long-term interest rates also rising, many investors wonder if the Fed will overdo monetary tightness again, causing an economic downturn.

So when minutes of the last meeting of Fed policymakers hinted they might end their anti-inflation drive and not boost interest rates next month, stock prices rose dramatically last week.


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