Surveying the Economic Horizon
When weather forecasts turn out wrong, we usually can make alternate plans that have little consequence in the larger scheme of life's events. In contrast, when economic forecasts disappoint, the consequences may be more significant. Nevertheless, making decisions about your financial future involves some guesswork, and an educated guess—even with elements of uncertainty—may be a better alternative than traveling into the future with no forecast at all.
Unfortunately, economic forecasting, like forecasting the weather, is far from an exact science. Even professional economists may strongly disagree on the direction of the economy at any given point in time, based on their differing interpretations of conflicting economic indicators. And, although many factors are important in assessing the economy, this discussion will focus on two key points that can help you get a better feeling for where our economy currently stands...and in what direction it may be headed in the near future.
How Much Longer...?
Economic forecasters are always searching for storm clouds that might signal an economic downturn. Since consumer spending has historically accounted for about two-thirds of the economy, many observers have looked to "pocketbook" issues in search of primary clues as to which way the economy may be heading.
While consumers don't usually cut back first and cause a recession, buying more on credit translates into greater monthly payments and, at some point, consumers can do only what their incomes will allow. With personal debt historically on the increase, keeping an eye on consumer debt levels is particularly important because of the sheer weight of total consumer spending in our economy. However, it may be wise to eventually concentrate your attention on current federal decisions that set the foundation for our overall economic climate.
The Role of the Federal Reserve Bank (the Fed)
Even the casual observer of business news knows that "Fed-watching" is a serious activity in the financial and business sectors. You may be asking yourself, "What makes the Fed so important?"
While consumers can affect the economy by acting according to their own perceptions and pocketbook pressures, federal policy decisions, such as fiscal and monetary measures, can also move the economy. Fiscal policy, enacted by Congress in the form of tax and/or spending legislation, is the by-product of the political process and the prevailing political climate. In contrast, monetary policy is the purview of the Fed, whose role is to evaluate all of the forces acting on the economy (individual, market, and governmental), and to take the action it believes will keep the economy on an even keel.
The Fed can manipulate the money supply in hopes of obtaining a desired effect over time. However, the Fed's most effective short-range policy decisions with which to manipulate the economy are short-term interest rates. Consequently, the Fed can realistically have only one target—inflation. If the Fed perceives that prevailing forces will increase inflation, it will attempt to slow the economy by raising short-term interest rates (the assumption is that increases in the cost of borrowing money are likely to dampen both personal and business spending behavior). Conversely, if the Fed perceives the economy has slowed too much, it will attempt to stimulate growth by lowering short-term interest rates (i.e., lowering the cost of borrowing).
In carrying out this balancing act, a very cautious Fed walks a fine line. If it doesn't tighten the reins soon enough (by raising interest rates), it runs the risk of inflation getting out of control. If it fails to loosen soon enough (by lowering interest rates), it can plunge the economy into recession. Indeed, one might argue that the primary goal of the Fed is to keep inflation low enough so that it is not a factor in business decisions.
Up, Down, or Sideways?
By looking at your own spending outlook and debt burden (and that of your friends, relatives, and business associates), you may gain some insight into the short-term future of the economy. While by no means the complete story, it does represent a large chapter since it is the one over which individuals can exercise the greatest control. When combined with a little judicious Fed watching (e.g., several interest rate moves in the same direction may be an indication that the Fed is on a mission), you may have a fairly good basis for making sound decisions with regard to your own financial future.