Snow! Oil! Spending cuts! The folly of GDP predictions

February 28, 2011: 12:06 PM ET

The fragile U.S. economy still faces headwinds, but just how much will they hinder growth? No one's quite sure, but everyone has an opinion.

snowstorm

Buried under a mountain of economic forecasts.

Economists are still kicking themselves for failing to predict the impact of the financial crisis on the economy. So perhaps that's why they've been particularly vigilant lately in their predictions for just how much the many headwinds we still face will slow the economic recovery.

It was only this past summer when many experts thought the U.S. could slip back into a recession. That hasn't happened, at least not yet. Not only did the American economy dodge a double dip recession in 2010, but GDP grew 2.8% -- the biggest annual increase in five years after the economy shrunk by 2.6% in 2009. Volume of all goods and services produced rose to $13.37 trillion in the final three months of 2010, the U.S. Commerce Department reported Friday.

But just when it appears the American economy has stabilized, a few factors have rightfully put experts on alert. Higher oil prices, efforts to slash government spending and bad weather can certainly weigh on the economy. Nearly every expert is weighing in on just how much one of these factors might slow GDP growth. What if they all happened and all of the forecasters are right? These headwinds – combined – would potentially put annual GDP to negative territory and far below the minimum 3% need to keep the country's annoyingly high jobless rate from trending up.

It's anyone's guess if the experts will turn out to be right, however. Gross domestic product in the world's largest economy will expand at a 3.3% pace in 2011, up from the 2.6% rate forecast in November, according to a survey of U.S. companies conducted by the National Association for Business Economics. Consumer spending, business investment and exports will also increase more than previously projected as demand from consumers, businesses and other countries pick up.

Nevertheless, here's a look at what cynics are saying.

Budget cuts – In an era of huge budget deficits, talk of spending cuts has pitted Republicans against Democrats over views on the size of government. Republicans have proposed a bill to dramatically slash spending by $61 billion in 2011.

While the parties hash out spending plans for 2011, Capitol Hill is abuzz over a Goldman Sachs (GS) report that says the Republican plan could reduce U.S. economic growth by 1.5 to 2 percentage points in the second and third quarters of the year. Democrats have widely cited the report – namely, Sen. Charles Schumer (D-NY), who has called the Goldman report a "non-partisan study" proving "a recipe for a double-dip recession."

A potential compromise deal – and a more likely scenario – with $25 billion in spending cuts this year would lead to a smaller drag on growth of 1 percentage point in the second quarter, according to the investment firm. Thereafter, it would fade, with "negligible" impact on output by the end of the year.

Whether Goldman's analysis is right on, the firm's grave forecasts of GDP have certainly given Democrats a few talking points.

Oil prices – Last week, crude in New York rose above $100 a barrel, marking the first time since October 2008 that it has risen to such levels. The worry among many economists is that further increases could weigh on U.S. consumer spending as the uprising in Libya has reduced supplies from Africa's third-largest oil-producing country.

James Hamilton, economist with the University of California in San Diego, has done extensive research on oil shocks and its implications on the economy. In a study, Hamilton found that the surge in oil prices, which surpassed $140 a barrel in the summer of 2008, helped send the economy into the Great Recession that started December 2007 and ended in June 2009. Certainly the housing and banking crisis played a major role, but so did oil shocks. The spike in gas prices hurt consumer spending, and especially the U.S. auto industry.

With the way prices are moving today, Hamilton doesn't see a double-dip recession. However, he estimates that today's high oil prices could reduce GDP by 0.5% for the year. That's no small reduction, especially when growth has been so slow.

But it's hard to say how much attention the bearish view deserves. U.S. Federal Reserve Chairman Ben Bernanke appears somewhat more optimistic when it comes to oil prices, even while he is expected tomorrow to continue the agency's program of buying up billions of dollars worth of bonds to stimulate the economy. Bernanke is expected to report that the spike in crude oil and gasoline prices are temporary shocks, and it's unlikely to have a material negative impact on the overall outlook for the next year or two, according to IHS Global Insight, a Massachusetts-based economic forecasting firm.

Snowstorms – For many economists, even seasonal headwinds pose a threat to the economic recovery. It's no surprise. The weather impacts everything from oil prices to harvest seasons to weekly unemployment claims.

And according to Macroeconomic Advisers' economists, GDP growth during the three months ending in March will likely come at an annualized 0.6 percentage point lower than it would have been if it weren't for the unusually cold temperatures in December and January.

Who knows if the macroeconomic analysis firm will be right on, but the firm's predictions highlighted in The Wall Street Journal show that virtually anything could impede economic growth. And it doesn't take much searching to find an economist who will quantify the impacts.

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About This Author
Nin-Hai Tseng
Nin-Hai Tseng
Writer, Fortune

Nin-Hai Tseng covers economics and finance. Before joining Fortune, Tseng was a reporter at The Orlando Sentinel and a public affairs associate at GE. She holds an MPA from Columbia University and a BS in Journalism from the University of Florida. She lives in New York City.

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