Forecasting Issues
There’s a big difference of opinion on the strength of the recovery.

Mr. Malpass is the Chief International Economist for Bear Stearns.
January 25, 2002, 8:00 a.m.

That adds up to a big difference of opinion on the strength of the recovery.

Estimates of real GDP growth for the fourth quarter of 2001 range from +1% to -2.5% (per Bloomberg), even though the quarter is over. The Wall Street Journal's annual survey showed a range in first-quarter forecasts from +5.4% to -2.8%.

Why is there such a range for the quarterly GDP forecasts? Inventories are an important swing factor in the near-term quarterly forecasts. For example, suppose companies restocked in January rather than December. This would show up as a more negative fourth-quarter and a more positive first-quarter GDP growth number.

Here's how the inventory swing works:

Bear Stearns' current forecasts are for -1% GDP growth in the fourth quarter and -0.3% in the first quarter. Its GDP forecast assumes inventories were drawn down by $101 billion in the fourth quarter and will be drawn down by only $53 billion in the first. This provides a $48 billion addition to GDP in the quarter. When annualized to four quarters, the $48 billion increases real GDP by about 2%.

If it turns out that inventories had a $20 billion bigger swing — a $121 billion drawdown in the fourth quarter and only a $33 billion drawdown in the first (because some restocking was done in January rather than December) — then the fourth-quarter and first-quarter numbers would be -1.9% and +1.4% (versus Bear's -1.0% and -0.3%). The total two-quarter GDP would be the same as in Bear's current forecast.

Note that the difference in forecasts is big, even though the economic difference (and the market impact) of the inventory swing is negligible.

Some forecasters predict a bigger swing in inventories in the first quarter than the example above. This makes possible a high first-quarter growth rate, but would overstate the underlying strength of the economy.

Yet, consumption and investment will be the key variables in the first half of 2002, not the inventory swing that shows up in GDP growth rates. In the current environment, quarterly GDP numbers won't be all that meaningful due to the inventory variable. Instead, final sales will be a useful measure for quarterly growth. It measures GDP excluding the inventory factor.

Why is consumption important? First, it may contract substantially in the first quarter. Second, it's a big part of GDP.

Personal consumption expenditures (PCE) grew only 1% in the third quarter of 2001, and may have grown 3.2% in the fourth quarter, prodded by tax-rebates and auto incentives. A jump in consumption is unusual during a period of rising unemployment. If consumption falls an expected 1.5% in the first quarter of 2002, it will partially reverse the fourth-quarter strength. This would also be reflected in weaker retail sales, relatively weak auto sales, and weakness in imports.

Consumption remains a risk in the recovery. Personal income fell in September, October, and November, a sharp change. In a similar vein, the total number of people working in the economy fell from 132.7 million at the March peak to 131.3 million in December, a 1.37 million decline. Both factors should put downward pressure on consumption, diminishing the "resilience" of the U.S. consumer that we saw in the first part of the recession.

And how much can government spending add to the economy? The annualized rate of federal government purchases was $616 billion in the third quarter of 2001, about 6% of GDP. Annualized state and local purchases were $1.22 trillion, 12% of GDP. Note that the government purchases are much less than total government spending because a large part of government spending is made up of transfer payments, such as social security.

Federal purchases should grow quickly, but state and local purchases will grow slowly, if at all. A "dire emergency" supplemental appropriations bill should arrive in the first half of 2002, further boosting federal purchases, and adding to the extra federal spending approved after September 11. However, several factors will keep government spending from adding much to the GDP growth rate.

First, not all of the appropriated funds are spent immediately. Some spending takes years for the project to be completed. And the emergence of a federal budget deficit will provide some constraint on federal largesse. State and local budgets are even more tightly connected to falling tax receipts, limiting growth in that part of government spending.

More, government purchases are not that big a portion of GDP, roughly 18%. Even if they grow fast, it will not have that big an impact on GDP.

Some of the more negative forecasters are even talking about the "double-dip" scenario — essentially meaning two back-to-back recessions. But that's not likely. Essentially, for the National Bureau for Economic Research to define the 2002 period as a double dip (a recession/recovery/second recession), GDP has to get back up to the previous highpoint and then shrink again. So, GDP would need to first grow roughly 2.6% for NBER to declare that the 2001 recession had ended. Then, GDP would have to decline enough to create another recession.

In the 1979-1982 double dip, the recovery lasted only 12 months, from July 1980 to July 1981. Monetary policy seemed to have been tightened in 1981 (by not accommodating the increased demand for liquidity due to the coming tax cut), unnecessarily causing the second recession. But don't expect the U.S. Fed to make this mistake by raising interest rates too soon.

No, we're not going to double dip. Instead, I'm holding to my forecast that the recovery will be bowl-shaped, and that there was a short-term upsurge — a blip — in the bottom of the bowl during last year's fourth quarter due to auto rebates, a manufacturing recovery, and other factors. That's a short upsurge, and not a recovery between recessions.