Is Money Still Vital in Economic Forecasts?
AFTER fourth-quarter 1993 statistics came out, many economists raised their 1994 economic forecasts.
``Almost everyone is now a believer in the [United States] recovery,'' write Roger Brinner and David Wyss of DRI/McGraw-Hill, an economic consulting firm in Lexington, Mass.
The consensus forecast for inflation-adjusted growth this year by the 50 economists surveyed earlier this month by Blue Chip Economic Indicators jumped three-tenths of a percentage point from their January forecast to 3.3 percent. That's a big move.
``The dissenting minority seems restricted to some Republicans hoping that their damnation of the income tax boosts will be vindicated, some monetarists clinging to the quaint belief that money aggregates are all one needs to know to make a good forecast, and a few perpetual doomsayers,'' Messrs Brinner and Wyss say.
Well, some monetarists - including the most famous one, Milton Friedman - don't take too kindly to the crack. Monetarists hold that the supply of money into the economy importantly influences future inflation and growth in the nominal gross domestic product (GDP), that is, the nation's output of goods and services in current dollars. The inflation-real growth mix is always somewhat uncertain. Dr. Friedman, who is a fellow at the Hoover Institution in Palo Alto, Calif., says the DRI economists have set up a straw theory. ``Those of us who are monetarists have said that nobody is very good at forecasting short-term trends in the economy, whether monetarist, Keynesian, or anything else,'' he says. The range of error in economic forecasts is about the same as the variability in the economy, one study found. So forecasts are not reliable.
Monetarists argue that the Federal Reserve should stop tinkering with interest rates, pump out a steadier supply of money to the economy, and that this would reduce the size of economic ups and downs.
To Friedman, who with Anna Schwartz wrote a renowned scholarly monetary history of the US, says the recent relationship between money growth and the economy is ``just as imperfect or good as it has ever been.'' Money supply figures do forecast reasonably well inflation two or so years in the future. Because the broad money supply has been growing so slowly over the past few years, Friedman says he's ``relatively confident'' that inflation will remain ``relatively low'' over the next two years. However, the money supply is not all that is needed to predict economic growth. ``But we don't know what else [in the way of statistics] helps in forecasting,'' he says.
The Fed says it pays little attention to the money supply because velocity - how fast money changes hands - has become too volatile. Since velocity has increased, that means a specific amount of new money produces more gains in output.
Friedman acknowledges that velocity shift. But he notes that when the broad measure of money termed M-2 grows rapidly or slowly in one quarter, nominal GDP follows suit in the next quarter. The information revolution has shortened what used to be a six-to nine-month lag between money supply changes and the effect on the economy, he says.
Another monetarist, Paul Kasriel of Northern Trust Company in Chicago, has found the same short lag, using both M-2 and another financial measure, growth in real bank assets. Using the latter, he anticipates real growth in GDP in the current quarter at a 3 percent annual rate, half of that in the previous quarter.
Mrs. Schwartz, an associate of the National Bureau of Economic Research in New York, also sees the economy strengthening throughout 1994, given the jump in velocity for M-2. ``I don't foresee any kind of problem that would derail the expansion.''
Another economist who pays attention to the money supply, Lacy Hunt of Carroll McEntee & McGinley, New York, holds that slow growth in the money supply for the past five years explains the 1990-91 recession and a recovery that has produced half the real growth and one-third the increase in living standards of the typical post World War II expansion. He expects the economy to continue to underperform this year, with only 2.25 percent growth and slowing as the months go by.
Friedman figures that slow recovery will avoid the stop-go expansions prevalent in the past. ``On the whole, the Fed has been doing very well, whether planned or not,'' he says.