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Bernanke's Programs May Dilute Greenspan Intuition (Update2)
Kiều , Gò Vấp, 0918 514376
By Scott Lanman
Nov. 22 (Bloomberg) -- Inside the U.S. Federal Reserve headquarters, a small team is testing a forecasting program that does the work of hundreds of economists. Never before has the Fed been able to crunch in real time such a large mountain of data -- as many as 150 indicators -- to divine where the economy is headed.
Chairman Ben S. Bernanke is pushing the ``factor model'' program -- so named because it reduces everything from home sales to mining capacity into a few weighted averages for making predictions. The Fed could use the help: Its gross domestic product forecasts, which influence its interest rate decisions, have missed the mark by an average of 1 percentage point since 2000.
``It's a powerful tool that can potentially improve the Fed's forecasts,'' says Richard Clarida, a global strategic adviser at Pacific Investment Management Co. and Columbia University economist who developed a factor model as an assistant Treasury secretary in 2001. ``Forecasting, especially in real time, is a challenge, and these programs are not swayed by the emotions or the conventional wisdom of the moment.''
Bernanke called the models ``especially promising'' in a speech in 2004. He should know. In 2000, as an economist at Princeton University, Bernanke created one that examined 78 economic indicators. He found that its short-term inflation and unemployment predictions were about as accurate as those produced by some 200 economists at the Fed, according to his published paper.
Human Superiority
``That was widely regarded as a successful piece of empirical work,'' says Princeton economist Mark Watson, a pioneer in the field.
Bernanke, 52, also found that computers have their limits. As part of his research at Princeton, he ran a program to see what would have happened if a computer had set monetary policy from 1987 to '98.
Forecasts from Bernanke's factor model were fed into the program, which adjusted rates based on certain rules. The result: Inflation and unemployment fluctuated by larger amounts than in real life, proof that Fed officials are better than software at making calls on interest rates.
``We find this evidence for human superiority comforting,'' Bernanke wrote.
Columbia professor Edmund Phelps, winner of the 2006 Nobel Memorial Prize in Economic Sciences, agrees. ``There's going to be a huge element of uncertainty left that is not captured by the computer models,'' Phelps says. ``Now is a time when there happens to be an unusual amount of uncertainty.''
Betting Against Recession
In February 2006, when Bernanke became Fed chairman, the economy was speeding ahead, expanding at a 5.6 percent annual pace, and inflation was holding steady. He gained credibility by halting the two-year run of interest rate hikes in August as growth started to slow. Now, he faces a more daunting set of facts: A plummeting housing market has raised the specter of a recession while inflation has nudged up.
Economists aren't providing much clarity. Their predictions for 2007 are sharply divided compared with their earlier calls for 2006. JPMorgan Chase & Co. argues that inflation will spur benchmark rate increases up to 6 percent. Goldman Sachs Group Inc., taking the opposite position, sees the distinct possibility of a recession and rate cuts to 4 percent. According to the median forecast of economists in an October-November Bloomberg News survey, officials will lower rates by half a percentage point to 4.75 percent in 2007.
Worst Over?
The Fed is betting against a recession even after the economy expanded at an estimated pace of 1.6 percent in the third quarter. The central bank has held its rate at 5.25 percent since June, hoping that growth is slowing just enough to bring inflation down to about 2 percent or lower.
The drop in crude-oil prices from July's peak of $78.40 a barrel and higher stock prices may provide a cushion for the economy, says former Fed Governor Laurence Meyer, now vice chairman of St. Louis-based Macroeconomic Advisers LLC.
``The worst may be behind us,'' concurs New York-based Neal Soss, chief economist at Credit Suisse Group. ``Consumer outlays have been very strong.'' A barrel of crude was worth $59.92 a barrel at 7:33 a.m. in London today.
Housing is a dark cloud in the calculations of other economists. Goldman Sachs says a recession is increasingly likely because this housing slump is worse than the last two, in 1995 and 1998-2000. New single-family home sales fell 23 percent in the third quarter, and the housing market has yet to hit bottom, says David Rosenberg, chief North America economist at Merrill Lynch & Co. ``The chance of a recession is a coin flip right now,'' Rosenberg says.
`Hard Time'
The Fed isn't any better at GDP predictions than private economists, though it does outperform them on inflation, according to research by the Federal Reserve Bank of St. Louis. ``Economists have a hard time forecasting turning points,'' Fed economist William Gavin says.
Factor models, which run on a basic desktop computer, may help officials with those twists and turns in GDP, inflation and employment. ``It makes it easier to see margins on which we could improve our reading on the ongoing state of the economy,'' says Jeffrey Fuhrer, research director at the Federal Reserve Bank of Boston.
The models emulate in a way how Bernanke's predecessor, Alan Greenspan, discerned economic trends from reams of data, says Princeton's Watson. ``Greenspan was someone who had great intuition and understanding about the economy,'' Watson says.
The central bank won't say when its factor model will be used to help set policy. For now, Bernanke will have to rely on his old tool kit to try to avert runaway inflation or recession -- whatever the case may be