Economists are reluctant to forecast recessions, especially since
they have become less frequent in recent years. It is professionally
damaging to wrongly predict such a slump.
Economists are less reluctant to warn of trouble ahead, such as a
housing bubble bursting, trillions of dollars in loan-related
financial packages coming unglued, or the dollar plunging as huge
United States trade deficits continue.
In general, economists do modestly better at predicting the
economy than simple mathematical projections of past economic trends
do. But economists often get into trouble when they try to foretell
Perhaps that's why most economists are cheery about the health of
the US economy.
Economists and policymakers at the US Federal Reserve also have a
history of upbeat forecasting. They didn't see the last recession in
2000 and 2001 until about nine months after it started.
That's typical, because the Fed and other economists rely on
financial data collected with a lag of a month or more.
"It is like driving down the road with your eyes glued to the
rearview mirror," says Harald Malmgren, a Washington consulting
economist. "When a bend in the road comes, this navigational
technique is unreliable."
Many stock-market investors are aware of this risk. Late last
month, the Fed raised short-term interest rates one-quarter of 1
percent for the 15th time since June 2004, to 4.75 percent. With
long-term interest rates also rising, many investors wonder if the
Fed will overdo monetary tightness again, causing an economic
So when minutes of the last meeting of Fed policymakers hinted
they might end their anti-inflation drive and not boost interest
rates next month, stock prices rose dramatically last week.
"If the Fed doesn't stop raising rates soon, the recession flag
could go up," warns Paul Kasriel, an economist at the Northern Trust
Co., a Chicago bank.
Yet he, like many other economists, sees problems for the
economy. "We have a very accident-prone global economy right now,"
Mr. Kasriel says.
Among the perils he and others see:
Risky mortgages, riskier derivatives
The Fed is concerned over the rapid expansion of nontraditional
mortgages, such as interest-only loans and those where the size of
the loan grows, rather than shrinks. The Fed and other US financial
regulators have produced a draft "supervisory guidance" for
participants in the US mortgage market. A final version of this
guidance, when it emerges, could constrain the home-mortgage market
later this year, Mr. Malmgren warns. Similarly, regulators are
trying to tame the market for risky loans linked to commercial real
In the international sphere, the Fed and banking regulators in
Britain and other nations worry about the rapid expansion in recent
years of high-risk "credit derivatives," now in the trillions of