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The economist whose bullish growth figures were right - but wrong

By DAVID R. FRANCIS / February 1, 1988



FOR an economist in the forecasting game, there is nothing like being right. Michael W. Keran, chief economist of the Prudential Insurance Company of America, had that satisfaction last week when the Commerce Department issued its preliminary numbers for the fourth quarter real gross national product (GNP), that is, the output of goods and services in constant dollars. Mr. Keran had predicted real growth at a 4.5 percent annual rate - much higher than most any other economist. The Commerce Department estimated 4.2 percent for the three-month period.

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``I am pleased we came in close to where we said it would be,'' Keran notes. Indeed, he suspects the Commerce Department will revise the annual rate to about 5 percent later in February. The GNP estimate, he explains, didn't include the latest high numbers for business equipment spending.

Some rain fell on Keran's celebration, however, when the GNP news prompted bond prices to go up. Usually news of a bustling economy prompts prices of outstanding bonds to fall, because investors figure the demand for loans is growing and will push up interest rates on new bond issues. Instead, traders saw in the GNP numbers a huge slump in consumer spending, resulting in a large buildup of business inventories and thus a slower economy this year.

Keran suspects the GNP revisions will trim those inventory numbers. But that won't help his insurance company's bond traders much; they acted on the basis of bond prices falling.

His forecast for 1988 calls for 2.5 to 3 percent growth in real GNP - ``a reasonable year.'' The consensus among other economists is considerably gloomier - 1.5 to 2 percent. In fact, more economists nowadays are talking of a recession.

For example, Bert Dohmen, editor of the Wellington Letter, worries that the ``dangerously slow'' growth in the nation's money supply since two weeks after the Oct. 19 stock market plunge could cut off economic growth. Last year's growth in the money measure known as M-1 was a minuscule 1.3 percent, the lowest annual growth rate since 1961.

Keran, who regards himself as a ``monetarist,'' believing in the relevance of money to the business cycle, is not worried, because his ``model'' of the economy says the economy will continue expanding despite slow money growth. That model, he says, has been forecasting ``reasonably well'' for two years.

During the 1950s, '60s, and '70s, the growth of the economy followed almost perfectly the supply of money. If the Federal Reserve added money, the pace of the economy stepped up after a lag of nine months or so. Slow down the money supply, and the economy slumped soon thereafter.

After 1982, however, that relationship fell apart. The velocity of money (how often it turns over as people engage in money transactions) fell instead of rising steadily as in the past. Many monetarist forecasts, based on the supply of money, were wrong.

Keran figures the monetarist mistake after the 1981-82 recession was not looking adequately at the ``demand'' for money. With lower interest rates, people were more willing to hold money rather than spend it right away. Velocity declined. Keran's model predicts money demand and shows velocity rising again. So the economy would get a bigger bang for each buck added by the Fed.

If Keran's recent forecasting accuracy continues, the nation's economy remains in good shape. If not, and the Fed does not ease credit, look out.