Economists tend to exaggerate their interpretations of economic data. Exaggeration may be all in a day’s work, but when the economy is experiencing a growth transition, it can be misleading.

by Stephen S. Poloz


Why do economists exaggerate? Perhaps it is to inject life into otherwise dry statistics. Or, it may reflect a preoccupation with short-term economic fluctuations. After all, financial markets (bonds, stocks and currencies) tend to also over-react to economic news, and one of the jobs of economists is to help traders make money from such fluctuations. In the end, exaggeration may simply be a way of standing out in a crowded, even over-analyzed marketplace.

In any case, exaggeration can make it very difficult for people in business to extract what they really need, which is a sense of what their sales might be in six months or a year. It is all too common to see the economy described alternately as “explosive” and then “falling off a cliff” in the space of a few weeks. It is almost as if either the lights are on, or the lights are off, and nothing in between is likely, when in fact the underlying business trend may be little changed.

This sort of whipsaw pattern in opinion can be particularly problematic when the economy is genuinely picking up speed or losing momentum. Such a transition is underway right now, as the world is experiencing a downshift in economic growth. This is, in fact, highly desirable. Central banks have had the pedal to the metal for over two years, and the world economy is now running at top speed – growth will be 4.2% for 2004, which is above the global speed limit. World growth must ease back during the next 12 months or so, whether as the result of higher interest rates, steep oil prices, or simply from consumer fatigue. Without this moderation, the risk of a boom and then a bust cycle would be very high, along with the potential for severe financial stress.

Growth typically is very rapid after a slowdown or a recession, as the level of economic activity catches up to normal, and then it moderates to a sustainable pace. This is much like engaging the cruise control on a car – the driver eases up on the gas, but the car maintains its speed. Nevertheless, the car’s engine slows down in much the same way when the driver is preparing to slam on the brakes. Pessimists, therefore, can sound the alarm the minute they see the economy gear back, even though the economy is fundamentally very healthy and will continue to grow.

World economic growth is forecast to ease back to a much more sustainable 3.7% for 2005. This moderation will be led by China, where growth will come down from around 10% to 7-8%, but an even more important role will be played by the U.S., which will slow from 4.5% to around 3.5%. Both economies are widely viewed as pivotal to world economic growth, which raises the possibility that the transition will attract undue angst and pessimism from analysts.

The bottom line? The world economy is slowing, as it must. There may be some depressing descriptions of the outlook as the U.S. and China go through this transition – and a lot of hope/angst swings – but astute observers will keep it all in context and go about their business.

Stephen S. Poloz is a Senior Vice-President and Chief Economist at Export Development Canada.