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2005: Where to Invest

Risks Cloud a Sunny Forecast

Job Picture Looking Up, Dollar Down

By Nell Henderson
Washington Post Staff Writer
Sunday, January 2, 2005; Page F01

The U.S. job market should improve steadily this year, while consumer inflation eases and oil prices decline -- all good news, that is, if nothing goes wrong with the sunny economic forecasts released in recent weeks by many private and government economists.

The economy should continue to expand at a pace that is "not too hot . . . not too cold . . . just right," Macroeconomic Advisers LLC, the St. Louis-based forecasting firm, wrote in a recent report to clients, lifting a line from the Goldilocks tale.

Oil trades lower at the New York Mercantile Exchange, while Saudi police guard plant near Dammam. Economists foresee a modest drop in prices. (Mary Altaffer -- AP)

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But, of course, forecasts often go awry.

"Lest we be too complacent about the future, we need only remember that the story ended with Goldilocks running screaming from the three bears' house," the firm said, citing several risks to its projections.

Even forecasts produced by the most advanced econometric models are essentially well-educated guesses about what is most likely to happen, based on past experience. And as such, they are subject to errors and surprises.

A year ago, many forecasters, including those at the Fed, overestimated how fast the economy would grow in 2004, in large part because they could not foresee the terrorist events, hurricanes and political turmoil that would send benchmark oil prices shooting to above $55 a barrel in October from around $35 in January. White House economists were among several who were over-optimistic about job growth, underestimating businesses' lingering caution and ability to squeeze more efficiencies out of their existing workforces.

With last year's twists and turns in mind, Macroeconomic Advisers warned that its forecast could be undermined by several "significant" risks in the year ahead: Oil prices could spike higher. The dollar could plummet, pulling down stock and bond prices. A terrorist event could hurt consumer, business and investor confidence. The burgeoning trade deficit could discourage U.S. production. Rising interest rates could slow spending more than anticipated. "The list goes on," the firm wrote.

Duly noted.

But the forecasts are produced, nonetheless, because they are needed for planning purposes by government policymakers, businesses and investors, who will base a variety of major economic decisions in part on their expectations for the coming year.

Fed officials are trying to decide how high and how quickly to raise their benchmark short-term interest rate. Executives have to make hiring and spending plans. Stock pickers must guess which companies will profit most.

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