The Economy: What Forecasts are Full Of
from
September/October 2003
by Rob Norton
How closely does a board member need to follow the ups and downs of the economy? Often it seems like a fool’s errand. In any given week a mind-numbing quantity of economic data, indicators, news, opinion, and predictions streams forth from the media. Much of it later turns out to have been misleading or wrong. Billionaire investor Kirk Kerkorian spoke for many a senior executive when he once said, “If economists were any good at business, they would be rich men instead of advisers to rich men.”
Yet it’s obvious that board members have to pay attention. “The primary reason,” says Mickey D. Levy, chief economist at Bank of America, “is that economic performance determines the business environment. If you understand the economy, you can provide much better guidance to executive management and also make better-informed judgments about how well the company is doing.”
So what should directors look for, and what can they safely ignore? Business economists agree that it’s easiest to say what not to do. “Most people,” Levy says, “board members included, have a tendency to pick up bits and pieces of economic information from their own backyard and extrapolate. They would be better served if they had a broader perspective.” A similar danger, economists warn, is the tendency to rely on random economic information from newspapers and TV. Every Christmas season, for example, the business media try to draw conclusions about the overall economy from fragmentary sales data and interviews with retailers and wholesalers. Last year grim headlines warned of “The Worst Holiday in 30 Years,” portending doom for the economy—but when all the numbers were in, retail sales proved to have gone up modestly, simply confirming that economic growth continued to be sluggish rather than signaling any change.
The best source of anecdotal information is the Summary of Commentary on Current Economic Conditions, published eight times a year by the
Federal Reserve Board. Known as the Beige Book and available free on the Fed’s website ( www.federalreserve.gov ), it collects commentary from the directors of each of the 12 regional Federal Reserve Banks, as well as from interviews with key business contacts, economists, market experts, and others. There’s nothing glitzy about it, but it is comprehensive and methodical.
As for specific economic indicators, many economists think the employment numbers are probably the best single measure of current conditions. Unlike some other headline-grabbing indicators, such as GDP growth and profits, the job numbers are not subject to significant revisions in future months, says Mark Zandi, chief economist at Economy.com, a leading provider of online economic news and data.
What would be truly useful to know is the economy’s future. Here board members are at the mercy of economic forecasters, whose record has never been great. In the January-February 2001 issue of New England Economic Review, economists at the Federal Reserve Bank of Boston went back and examined 70 individual forecasters’ records from 1996 through 2000. They found that on average, real-GDP forecasts for the next year were about two percentage points below the actual data, and unemployment-rate forecasts were about half a percentage point too high—huge errors.
Flawed as they are, economic forecasts are the best tools available. One of their useful features is the section usually titled “Risks to the Forecast,” which assesses what might happen if things don’t go according to plan. “Directors should concentrate on that,” says William Dudley, chief U.S. economist at Goldman Sachs. “What are the risks, what’s the likelihood of those outlier events, and from a business perspective, what are the serious consequences if the forecast is off?”
Perhaps most important, board members need to connect a forecast to the company’s business plan. “They should come to an understanding of what industry they’re in and how that industry tracks with broad measures of the economy, such as nominal GDP growth or real GDP growth,” says Mickey Levy, who briefs Bank of America directors regularly. “Board members should find out what drives the top line of the business and what drives its margins. Then they can focus on the facets of the economy that are most important to the business.”
