How to Read the Music of Economic Forecasts
For me, it’s always been intuitively easy for me to tell the difference between a theoretically trained and technically savvy instrumentalist and an innately talented self-taught one. Jimi Hendrix and Charlie Parker, for instance, couldn’t read music; but, their pitch, emotional expression, and intuitive ability to connect their unique ideas to their sounds were perfect. On the other hand, you have extremely cerebral musicians who channel decades of technical prowess into densely detailed compositions such as Frank Zappa, Jonny Greenwood, or Andrew Bird. There’s no right or wrong way to approach music. But, one thing is for sure: if you don’t have the innate chops and talent of the likes of Hendrix or Parker, ignorance is not bliss in this case.
Like music, the economy should be seen like an instrument. But, here, I advocate for technical prowess. While some politicians, like Bernie Sanders, can harp on the strings of data metrics and translation of numbers with a rhetorical nuance of untrained elegance; much of the time, public figures are like musicians trying to play insanely hard music while not being able to read the notation. We should strive to be Zappas not Hendrix when it comes to data and numbers. But, we also shouldn’t be eggheads. First, we need to break down the economy into basic chunks of information. The notes, the time signature, etc. If you’re learning a new language, it’s best to start with the essential building blocks. The goal: understand the economy as if we can speak the esoteric language it hides behind. If the numbers can make more sense, perhaps the politics can become less short-sighted and irrational. Maybe we can also hear the music.
LET’S START WITH THE BASICS OF ECONOMIC FORECASTS
GDP is the broadest data-based metric used to measure America’s overall domestic economic output. In other words, the GDP is the total amount of money spent domestically in the economy. ‘Output’ includes: personal expenditures (Personal Consumption Expenditure or PCE); business and Investment expenditures (Gross Private Investment or GPI); Federal, State, and Local Government spending on investments and expenditures; and net exported goods that businesses send to other countries (with reported imports equated to counter total exports). ‘Expenditures’ should be seen as money spent by a group on goods and services and can also be called “consumption.” In the case of business and investment consumption, we look at data such as money spent on homes, incomes, plants/firms, and equipment. This allows us to understand how much money a business has spent and how much money they made (value-added or revenue). All of this data is then added up into one number. GDP metrics are produced quarterly and are revised as data comes in making it more precise from sampled firms. GDP’s “Real” value is equated by taking GDP’s Nominal Growth and accounting for Inflation (i.e. price changes).
The Unemployment Rate is the population of unemployed individuals inside the labor force (i.e. individuals who are employable and looking for a job) and divided by the net number of unemployed and employed individuals. Numbers for this emerge from data collected by the government in Establishment Surveys and Household Surveys. The Establishment Survey consists of data, collected from 160,000 firms, expressing the number of jobs created in the economy in a given month. Household surveys consists of data collected from 55,000 Households and includes data on individuals excluded by the establishment survey. These groups include self-employed unincorporated workers, unpaid workers, agricultural workers, and private household workers. Economists traditionally place emphasis on the Establishment Survey distributed by the Bureau of Labor Statistics (which is also the Unemployment Rate projected by the CBO) because it consists of a larger sampling size, making it less susceptible to the volatility of the housing sector and sampling error. The goal of quantifying the Unemployment Rate is to discern the Non-accelerating Inflation Rate of Unemployment (NAIRU). This gives economists a clear idea of a balance of unemployment they believe the economy should achieve. If the economy goes above this balance, they can predict prices falling; if it goes below the determined balance, prices rise.
Understanding the rise and fall of the general prices of all goods and services is the study of Inflation. Inflation is measured as the annual percentage change of prices compared to last year. This rate is otherwise called the Consumer Price Index (CPI). It is a survey of all collected prices across the country of goods and services. It traditionally aims for a target of 2% annual growth. Because food and energy prices are volatile, much like the housing market when assessing the unemployment rate, they are excluded by the Fed when understanding annual price ranges. Doing this quantifies the Core Inflation Rate. Achieving a 2% CPI annually is to achieve a balance between Inflation and Deflation. When Inflation exceeds 2% there are consequences. A “Cost Push” can occur. This is an increase in the prices of raw materials or wages that leads to firms increasing the prices of products they produce. If this escalates, the value of goods and services becomes unstable and the currency exchange becomes unmanageable. Deflation occurs when prices fall and consumers pullback from purchasing and spending money in the economy. This is the economy running out of gas and manifests as a decline in asset values.
Inflation is countered in monitory policy through the Fed’s adjustment of Interest Rates (making it cheaper or more expensive to borrow money) and firms increasing Productivity Rates (when workers produce more goods in less time). Interest is accounted for by taking the nominal interest accumulated minus the inflation rate. This deduces the Real Interest Rate. If interest rates are projected to increase, economists expect consumers to sell assets thus slowing economic growth. If they are expected to decrease, economists expect this to trigger economic growth. Interests Rates are traditionally viewed through the annual change in interest in 10-Year Treasury Notes. These are Government loans with a 10-year maturity. When assaying Interest rates, or “yields”, economists look at what is called “the yield curve.” This is a graphic showing the difference between short-term 3-month interest maturities (i.e. “bills) versus the longer term 10-year “notes.” A positive yield signifies a growing distance between the value of long-term notes and short-term bonds. This is seen as long-term yields becoming larger than the short-term yields. A flat yield signifies both yields being equal. An inverse yield is a short-term yield become larger than a long-term yield. A flat or inverse yield, to economists, indicate a looming recession.
3 SOURCES OF ECONOMIC PREDICTIONS: CBO, FOMC, AND BLUE CHIP
Three institutions have released predictions of percentage changes from Q4 2020 to Q4 of 2021: the CBO (Congressional Budget Office), The Federal Reserve (the Federal Open Market Committee), and Blue Chip.
The CBO is a non-partisan arm of Congress, charged with the duty of represented Congress in its projections and understanding of the economy. Because of its tie to Congress, the CBO has strong incentives to be accurate, credible, and to represent Congress in a non-partisan way. As a non-partisan organization tied to the most powerful legislative body that constructs monetary policy, the CBO does not want to not make assumptions or partisan associations with the White House or Congress. Thus, it bases its projections on current laws (excluding ongoing or proposed pieces of legislation from the White House or Congress).
The FOMC is a similar branch of economic policy-making economists who work with the Federal Reserve. These representatives publish expectations about the economy and recommend monitory policy actions to the Fed in response to their projections. Because the Fed is given the responsibility of overseeing the interest-rates of the economy and acting as the main custodian of economy policy implementation, the FOMC has just as much incentive as the CBO to construct effective and accurate forecasts.
Blue Chip is a consensus summarizing the views and projections of 50 private economists working for specific major corporations. These firms include institutions making up a significant portion of the country’s GDP including Goldman Sachs, Fannie Mae, AIG, and Morgan Stanley. Because private interests are tied in projections made, these economists have to serve their internal audience of clients they represent and the external audience of potential clients and stockholders of their firms they are working with. Thus, private accountability for accuracy of predictions is not as serious as public institutions responsible for implementing monetary policy. However, because these institutions are major players in the economy and hold tremendous clout, their forecasts are closely watched by public institutions.
THE DATA PROVIDED BY ALL THREE SOURCES IN ONE TABLE: (SPOILER: ALL FORECASTS PROVIDE EVIDENCE OF ECONOMIC IMPROVEMENT)
Today, latest Real GDP output from the 4th quarter of 2020, reported by the Bureau of Economic Analysis, was $18.7803 Trillion. The 4th quarter of 2019’s GDP was $19. 254 Trillion. This demonstrates a -2.5% drop in GDP from 4th Quarter to 4th Quarter. Three institutions have released predictions of percentage changes from Q4 2020 to Q4 of 2021: the CBO, The Fed (the Federal Open Market Committee), and Blue Chip. All three groups estimate positive growth in GDP: the CBO estimates 3.70% growth, Blue Chip predicts 3.8% growth, and FOMC predicts 4.2% growth.
All three institutions forecast a contraction of unemployment. In April of 2020, at the height of the pandemic, over 6.2 million jobless claims were filed. The BLS report expresses this dip with an April employment level of 130,161 thousand (a net of 392,393 thousand jobs reported lost between March and April). All unemployment rates currently projected for 2021are negative. The CBO currently predicts 2021 Unemployment to drop -1.5% to 5.3%; Blue Chip predicts a -1.6% drop to 6.8%; and the FOMC predicts a -1.7% drop to 5.0% unemployment.
Inflation forecasts predict positive CPI growth. The CBO predicts a +0.4% increase in CPI to 1.6% and Blue Chip forecasts a +0.7% to 1.7%. While the FOMC does not take in data to account for CPI, it does account for the Personal Consumption Expenditure price index. This is the metric for “private consumption” when accounting for the GDP. According to the FOMC, PCE is projected to grow +0.4%, landing at 1.8%. Below is data released from the BLS showing Core and Nominal monthly inflation percentage changes.
Institutions predict a positive yield curve in regard to interest rates. The CBO estimates a 0.2% increase in 10-year Treasury Note interest and Blue Chip estimates interest remaining at 0.9%. Below, the FOMC shows the yield curve steepening with a interests at 0.93 in December of 2020, 1.11 in January 2021, and 1.31 in February 2021. This is still starkly different than the metrics conveyed by the FOMC in 2019–2020. December of 2019 had a yield of 3.06%, January 2020 2.89, and February 2.75. Still, this comparatively demonstrates the curve re-steepening.
THE OMB’S POLITICAL TENDENCY TO INFLATE PREDICTIONS
The Office of Management and Budget (OMB) has still not released its 2021 projections. However, compared to the Trump Administration, known to release rhetorically overly-optimistic forecasts to project political optimism, it will have watched each of the projections already released to reach an economic conclusion with more than likely increased scrutiny. Since the OMB is an arm of the White House’s fiscal and monetary policy implementation, its forecasts include legislation the White House hopes to pass, thus, erring on the side of optimistic partisanship when predicting the state of the economy. It is safe to say, given the new Administration’s expressed priorities to create tangible and demonstrable results of economic recovery from the ongoing pandemic; their number will reflect a different approach and outlook to the economy that the Trump Administration’s.
The table below demonstrates that, apart from the 2008 Recession and its subsequent recovery, Democratic administrations have traditionally adhered closer to institutional predictions offered than Republican Administrations. Particularly, note the 1980’s compared to the Clinton-era 90’s. After a diversity of opinions beginning in 2008 as a result of the Recession, and having experienced the whiplash of an economic boom and bust in less than a year, all institutions will be playing it safe even when anticipating growth. In short, Blue Chip, the FOMC, and the CBO are watching each other closely. Each of their projections fall within 0.1% — 0.2% of each other. The only exceptions are the FOMC’s prediction of a 4.2% growth in GDP and Blue Chip’s prediction of unemployment staying higher (at 6.8%).
Traditionally, Blue Chip tends to fall between White House predictions and public forecasts from Congress. Several individual members of Blue Chip’s consensus were pessimistic in their forecast numbers: ACIMA Private Wealth estimated a 2.0% GDP increase, UBS estimated 1.0% (a drop) for CPI, and Georgia State University forecasted Unemployment to be 8.4% (an increase). These are outliers, and, coming from relatively unknown sources to quantify a consensus demonstrates flaws in the underlying infrastructure of Blue Chip’s data. Some of these conjectures can be viewed as strategic data outputs used to get media attention. The FOMC is currently predicting slightly better numbers than the CBO. As its committee members meet every 7 weeks to oversee the economy, and, have dealt with the direct implications of legislation passed and not passed by Congress, it can be seen as the network farthest away from the partisan debates surrounding the pandemic and closest to the implementation of monetary policy. It foresees a boom as a result of the economy starting back up, primarily in the service industry. This aligns closely with data from the BLS, shown below:
Given past data and adherence to what is being released by the BEA and the BLS, it is easy to foresee both the CBO and the FOMC releasing plausible predictions for 2021. It would be wise for the OMB to err on the side of caution; executing predictions that give it room to exceed expectations rather than set the bar higher than it should. Given the Biden’s rhetorical approach regarding vaccination goals (100 million vaccinations in his first 100 days — a very attainable goal that gave the administration narrative power by completing their goal 60 days early), it would not be surprising to see his economic forecasts using a similar technique. On top of that, borrowing money will remain as cheap as it can be: FOMC economists are strongly urging low interest rates and are in agreement with newly appointed Treasury Secretary Janet Yellin to run the economy hot, instead focusing on lowering unemployment.
Economic officials working in lock step to focus on low interest rates and ensuring higher wage rates, rather than focusing on inflation, demonstrates a high possibility of more money being spent into the economy. As vaccinations increase and service industry jobs slowly trickle back into the employment metrics, monthly reports are indicating a steady climb as implicated by all three forecasts.
Let the music play on.
