The Federal Reserve's bullish economic outlook for the year cheered investors initially when it was released Tuesday, but it appears to be too rosy, several economists said this week.
Central bank policymakers predict a big pickup in economic growth with tame inflation and slowly rising interest rates, according to their semiannual monetary report to Congress, which was delivered Tuesday by Fed Chairman Alan Greenspan.
"Chairman Greenspan donned his Goldilocks outfit," in presenting the report, Ethan Harris, chief U.S. economist for Lehman Brothers Global Economics wrote to clients yesterday. "We think he is being a bit overly optimistic."
The Fed's forecast matters because it reflects the expectations of most of the central bank's policymakers as they make decisions on interest rates in coming months, said Peter Morici, a professor at University of Maryland's business school.
The report's "forecast is really too optimistic," Morici said. "The real danger is that they overreact and raise interest rates too much and too fast, a mistake they have made in the past."
The central bank's forecast also influences long-term interest rates, which are determined by financial markets, analysts said, noting that rates rose last week after the report was released. The yield on the benchmark 10-year Treasury note, which influences mortgage rates, rose to 4.43 percent yesterday from 4.35 percent Monday. Rates rose in part because bond traders and investors calculate that stronger growth means either that inflation will rise or that the Fed will raise short-term rates more aggressively than otherwise to keep it under control.
A Fed spokeswoman declined to comment on the criticism.
In particular, critics questioned the forecast by most members of the central bank's top policymaking group, the Federal Open Market Committee, that the economy will grow between 4.5 percent and 4.75 percent this year, on an inflation-adjusted basis.
That would require "a virtual explosion in growth" in the second half of the year, because the economy expanded much more slowly than that in the first six months, said Mickey D. Levy, chief economist at Bank of America Corp., echoing other analysts.
The economy grew at a 3.9 percent annual rate in the first quarter of the year, the Commerce Department has said. The department will report the second quarter's growth on Friday, but most private analysts put it somewhere below 4 percent. Several economists estimated that the economy would have to grow at a more than a 5 percent annual rate for the rest of the year to hit the Fed's forecast -- at a time when interest rates are rising, the effects of the last federal tax cut are fading, the stock market is sagging and consumer spending has been flagging.
Greenspan said Tuesday that the economy is going through a "soft patch" that should pass. He did not mention the FOMC forecast in his testimony, but said economic activity has "quickened" this year, and the expansion increasingly appears to be self-sustaining.
Greenspan's upbeat comments were followed by "a chorus of bullish comments" from other Fed officials through the week, Harris said. "There is some cheerleading going on here," he said.
Morici suggested another reason for the report's tone. "My concern is that they are putting out this very optimistic view because of the election," he said. "It's optimistic to the point of being suspect, making speculation about political motivation fair game."
However the forecast is the product of 18 central bank officials from across the country -- including the 12 regional Fed bank presidents and six of the seven Fed Board members -- who gather regularly as the FOMC to decide interest rate policy. Although Greenspan, as FOMC chairman, delivers the monetary policy report to Congress, he does not participate in the process that produces the forecast. That was also the custom of his predecessors Paul A. Volcker and G. William Miller.
The figures are not an average, but rather the so-called "central tendency" of the individual member's predictions, reached after throwing out the three highest and three lowest.
The group has the latest Fed staff's forecast in hand before they make their own, but the staff's work is not released publicly until five years later, as part of the transcripts of the policymaking meetings.
The officials' estimates are often wrong -- both in election and non-election years.
In their report in June 2003, they underestimated growth, not foreseeing the boom that occurred last summer when the combination of rock-bottom interest rates and a federal tax cut propelled the economy to expand at a sizzling 8.2 percent annual rate.
The officials' growth forecast range is wrong more than half the time, according to a study last year by two Fed staff researchers.
The policymakers generally missed the large decline in inflation that occurred from 1981 to 1986 and the recessions of the early 1980s, the early 1990s and 2001, the researchers found.
"Economic forecasters are notoriously bad at predicting turning points," the researchers wrote. "The FOMC members are no exception."