WASHINGTON (MNI) – The following are the remarks of Atlanta Federal
Reserve Bank President Dennis Lockhart prepared for the Tuesday night
presentation to the CFA Society of East Tennessee in Chattanooga,
titled “Expectations and the Economy:”

I want to thank the East Tennessee chapter of the CFA Society for
inviting me to speak this evening. I always start with a disclaimer, so
let me get that out of the way up front. These are my personal views and
not necessarily those of my colleagues at the Federal Reserve or on the
Federal Open Market Committee (FOMC).

Each Reserve Bank has quite a lot of resources devoted to
preparation for a regional president’s participation on the FOMC, where
monetary policy is made. Our work at the Atlanta Fed in support of
monetary policy involves a number of tasks. These include tracking data,
running econometric models, reading the analysis of others, and talking
to economic actors like you. From all this information, we construct and
continuously adjust a narrative that tries to explain where the economy
is and where it’s going.

I’m not going to say much on policy this evening. Rather, I want to
spend some time reviewing the economic story of 2011, as the year built
to today’s situation, in an effort to provide perspective on what you’re
hearing about the economy. Everyone in the world of economics is pretty
much privy to the same data. Yet, in interpreting signals from the data,
serious observers can arrive at quite divergent views on the state and
direction of the economy. Today, serious predictions for the next 15
months range from forecasts of impending recession to an outlook for
slow but improving growth. Among those holding the no-recession view,
there are a variety of opinions on how vulnerable the economy is to
negative shocks. Notably absent are predictions of growth rates
consistent with, for example, a rapid pickup in job creation.

I won’t test your attention span by reciting the ups and downs of
every important data element measured in the economy over the last nine
months. But I do want to provide enough of a timeline to convey the
movements and swings we’ve seen over the year by looking at three cuts
of the information. They are, first, the objective economic conditions
on the ground; second, the direction-better or worse-of the data; and,
third, the degree of surprise versus expectations as economic indicators
came in.

Why consider how the numbers came in relative to expectations?
Because expectations, particularly at this juncture, can influence how
our economic fortunes actually play out. A week ago, in an interview
following his winning the Nobel Prize in economics, Thomas Sargent, who
is an adviser for the Atlanta Fed’s Center for Quantitative Economic
Research, is quoted as saying, “What’s going to happen is going to
depend partly on what you think is going to happen.” Hold that thought.

First quarter: very little growth

The basic story of the first half of this year was one of
disappointment versus expectations. At the beginning of the year, the
consensus forecast had gross domestic product (GDP) growth for 2011 in
the range of 3 to 4 percent. Though the Atlanta Fed’s forecast was at
the lower end of that range, we generally shared the view that the
recovery was firmly established.

But as first quarter data came in, they did not live up to
expectations. The forecast was revised down, and we now know the economy
is estimated to have grown at a meager 0.4 percent in the first quarter.

The oil and commodity price shocks early in the year, along with
severe weather events, seemed to provide an explanation for the negative
surprises to first quarter growth. You can add some impact from the
March 11 tsunami tragedy in Japan, but most of that impact was felt
later.

A pretty clear picture of just how bad the first quarter was became
apparent toward the end of the second quarter, when the FOMC met in late
June. At that point, notwithstanding weakness in the early months of the
year, the widely held outlook was that growth would rebound in the
second half. Many anticipated that the effects of the price and disaster
shocks would quickly dissipate.

Second quarter: rethinking our position

Now let’s move on to the second quarter. As data on the second
quarter came in, many forecasters, including us, were surprised that the
data were on the downside of what were already modest expectations for
the quarter.

Let me mention parenthetically that, given the complexity and
dynamism of the economy, forecasting is fraught with errors and misses.
One of my colleagues says the only thing he can forecast with certainty
is that his forecast will be wrong. It’s when forecasts are persistently
wrong in the same direction, and by a substantial measure, that you
worry you’ve missed the real story.

As the summer progressed, the data surprises were unrelenting and
on the negative side of expectations.

By the time of the early August FOMC meeting it was clear to my
Atlanta Fed colleagues and me that we had to rethink our position. The
momentum of the economy looked a lot weaker than was our assessment
earlier in the summer.

A lot of worrisome stuff was piling up. For one thing, revised data
revealed that the weak first quarter was one of a succession of
progressively slowing quarters and not merely the result of one-time
events.

Further, the weakness in growth seemed to be more broad-based than
earlier price and disaster shocks could account for.

Add to this information that in late summer there were, in rapid
order, a number of blows to confidence. In addition to the GDP
revisions, there was the debt-ceiling battle, the S&P downgrade of the
U.S. credit rating, Hurricane Irene and the storm damage on the East
Coast, stock market volatility, and an initial report of zero job growth
in August. And very prominently, the European debt crisis seemed to
worsen, which again raised the possibility of spillover into the U.S.
financial system and economy. All this worked to change views about the
underlying fundamentals of the U.S. and global economies. As a
consequence, growth estimates for the second half of the year and into
2012 were marked down substantially by most forecasters.

Third quarter: gradually improving economy

The somewhat overlooked story of the period since the end of August
is that much of the incoming data have exceeded most forecasters’ low
expectations. For the third quarter at least, it appears that downgrades
of growth forecasts have been too pessimistic.

Admittedly, the economic environment today is characterized by
heightened uncertainty. That uncertainty itself can act like a negative
shock to the economy if investment and consumption decisions come to be
driven by worst-case scenarios of extremely sluggish growth, at best,
with a very good chance of sliding back into recession.

My view is that this worst-case scenario is less likely than it
appeared to be a couple of months ago. I don’t expect a double-dip
recession, at least in the absence of a significant negative shock. I
think recent positive surprises in the data should give pause. I think
it’s too early to draw fatalistic conclusions about the course of the
economy. As I see it, recent data and anecdotal reports are signaling a
gradually improving economy, and I think this point needs to be
recognized. In support of this view, I’ll paint a picture from our
working with the data. We at the Atlanta Fed regularly monitor the data
series that directly enter into the GDP calculation, along with
important other series, including employment. We compare these data
elements to Bloomberg’s published consensus expectations for each. In
the months leading up to July, the downside surprises in the data
dominated. In August and September, upside and downside surprises were
roughly equal. But in October, the surprises have generally been to the
upside. Importantly, these surprises to the upside exceeded expectations
by a significant measure. I’ve concluded an unqualified narrative of a
downward trend is unjustified.

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** Market News International Washington Bureau: 202-371-2121 **

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