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Fog of war clouds forecasts of US economy

February 01, 2003 13:14 IST

War jitters are clouding the US economic outlook, making it hard to discern the recovery's underlying state of health and difficult to forecast what will happen when the current uncertainty lifts, economists say.

"What happens this year is sort of anybody's guess," said Martin Baily of the Institute for International Economics.

Like many economists, Baily, who served as a top economic adviser to former President Bill Clinton, believes concerns over the potential damage a war could wreak on the economy has already made businesses reluctant to hire and spend.

But he also said the US recovery is being restrained by more than just concerns over a possible war with Iraq.

"We had an excess of (business) investment, we had a way overvalued stock market and we are still working our way through those things," he said.

In the view of economists at the Wall Street firm Goldman Sachs, war fears take a back seat to a hangover from the bursting of a stock market bubble.

"It simply isn't plausible that households or firms are retrenching because there could be a war halfway around the world, a war in which the United States is expected to prevail quite easily," Goldman Sachs economist Jan Hatzius wrote in a recent note to clients.

In a recent survey, the newsletter Blue Chip Economic Indicators found forecasters, on average, looking for growth of 2.8 per cent this year, which would mark a slight pickup from last year's sluggish 2.4 per cent.

In general, economists see a weak first half of the year followed by accelerating growth once war clouds pass. But there appears to be an unusually large range of forecasts, in part because of split views over what is holding the economy back.

Weighing the risks

In announcing its decision to hold interest rates steady at four-decade lows earlier this week, policymakers at the Federal Reserve gave the war-fears argument a nod.

"Oil price premiums and other aspects of geopolitical risks have reportedly fostered continued restraint on spending and hiring by businesses," the Fed said in its rate announcement, adding the economy should improve "over time" as risks lift.

Some analysts said the Fed's phraseology of "reportedly" and "over time" suggested policymakers at the central bank see the recovery saddled with more than just war.

Nevertheless, the central bank reiterated its view that economic risks were balanced between weakness and a possible rise in inflation -- a view some analysts see as disingenuous.

"The economy clearly has a downside risk that exceeds any risk of inflation at this juncture," former Fed Governor Wayne Angell said. "They've misled the market a little on the side that the prospects for recovery may be brighter than they actually think they are," he said.

However, some think the economy could show surprising strength if war-related economic risks fade.

"The risks in the near-term are titled to the downside and they are significant," said Rick Egelton, deputy chief economist at BMO Financial Group. "Longer-term, if this (war) cloud is to rise, I think the risks by and large may be on the upside."

Egelton said extremely low interest rates, coupled with the prospect for stimulative tax cuts, suggest the economy could be growing solidly by year-end.

Crystal ball

Even some economists who question whether the cloud of war is the main factor restraining growth see better days ahead.

"The dynamics are good," Conference Board Chief Economist Gail Fosler said. A pickup in consumer spending in the final month of last year and the extremely low level of inventories held by businesses suggest production is likely to get a boost early this year, Fosler said.

She also thinks businesses will soon need to raise spending on high-tech gear, which has a relatively short useful life.

"You're getting to the end of being able to implement a kind of break and fix strategy with respect to your (information technology) spending," Fosler said.

"There are clearly downside risks but it would be hard to say ... those risks are predominant," she said.

While it may come as no surprise economists are not speaking with one voice, the range of opinions is striking.

However, forecasters do seem to agree on one point, the U.S. economy, while it may look forward to better days, is not yet out of the woods.

"I'm sorry I don't have a better crystal ball for you, but I actually don't think anybody else does either," Baily aid.

Tim Ahmann in Washington
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