Guesstimate Time for Economists
For Donald Straszheim and his peers, forecasts are driven by a few assumptions
THIS time last year, Merrill Lynch chief economist Donald Straszheim began hammering out his economic forecast for 1996.
Whatever the prediction, Mr. Straszheim knew that the key to his forecast was his assumptions: What could the brokerage-house economist suppose about the elements of the economy that were governed by policy? Would Congress and the president balance the budget? What would the Federal Reserve do through the year?
Of course, Straszheim is not alone in trying to get beneath the economic data. Behind nearly every economic forecast written or broadcast in recent days is a set of assumptions.
"The forecasts differ according to the different weights economists put on different things," explains Bob Eggert, who runs Blue Chip Economic Indicators in Sedona, Ariz., which tracks the forecasts of 51 economists.
Indeed, economists make a lot of assumptions. The key ones involve fiscal and monetary policy. Yet economists will also assume there is no war in the Middle East or a renewal of the arms buildup in Russia. They will assume most of the nation will have normal weather, resulting in steady crop prices.
Sometimes these assumptions can get an economic forecaster into trouble. Last year, few economists expected the collapse in Mexico would cost the US economy $20 billion in net exports.
"The biggest mistakes have been where we had disasters," says David Wyss, an economist at DRI/McGraw-Hill in Lexington, Mass. For example, few economists expected a recession following the Gulf war.
In the 1980s, economists assumed that Congress and the White House would stop running large budget deficits. As a result of that mistake, most economists underestimated the strength of the economy in those years.
Aware that faulty assumptions can cause embarrassment, Straszheim made two key economic suppositions as he worked on his forecast for 1996.
First, he assumed that Congress and President Clinton would reach an agreement that "approaches" a balanced budget by 2002. "We made that assumption six months ago when the president was saying he thought it was best to be carrying a $200 billion deficit for the next seven years," he says. Behind the assumption was his conviction that the country's conservative course would force Mr. Clinton to make a deal. If this deal does not materialize, then Straszheim admits he will have embedded a wrong assumption that could make his forecast inaccurate.
Once a budget deal is struck, Straszheim assumes, the Federal Reserve will lower interest rates. He is assuming that the economy will be weak enough and inflation low enough to allow the Fed to reduce rates another half a percentage point by March.
Some less important assumptions are also woven into his forecast. He doesn't expect US-Japan trade differences to result in a break in trade relations. He does not expect the US military effort in Bosnia to have any adverse impact on consumer sentiment even if the action turns violent. And, the election will have no impact on the economy.
Given these assumptions, Straszheim, looking at the economic data, has decided that the economy will be "a little bit weaker than average," but without recession. Still, he forecasts growth of gross domestic product - the sum of all goods and services - at 2.4 percent. This is in the upper third of 50 economists surveyed by Business Week magazine. The Business Week consensus forecast is for GDP growth of only 1.9 percent.
Straszheim foresees continued weakness from consumers. "We are in for many lousy years for the consumer sector," he says. He bases his assessment on a demographic change. Baby boomers are no longer in an acquisition phase. He also believes the country has too many retailers, resulting in too much competition for the sector. His forecast is for virtually no growth in auto sales and moderate growth in housing.
Instead, he sees the economy as driven by the capital-goods sector and trade. Capital spending has become an important tool in corporate cost-cutting and restructuring. Straszheim notes that 25 years ago, companies spent 12 percent of their capital budgets on high-tech products. Now, they spend more than 50 percent. In the trade area, he foresees Mexico and Japan as the year's two "turnaround" economies. He predicts a return to growth for both. Europe will remain stuck in a slow-growth phase.
But what happens overseas will have only a minor impact on the economy compared with what happens in Washington. If there is no agreement to balance the budget in seven years, Straszheim says it's unlikely his forecast will come true. "It wouldn't come close to right," he says. A key assumption will be wrong.