–Retransmitting Text Published 18:30 ET Tuesday

WASHINGTON (MNI) – The following are excerpts from 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:”

—

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.

—
There is certainly downside risk to this picture. While there are a
number of risk factors, in my view, the two most prominent at the moment
are financial instability from developments in Europe and further loss
of confidence if the so-called congressional “supercommittee” here in
the United States fails to reach agreement-that is, if the
supercommittee is unable to arrive at a credible and sufficient fiscal
rebalancing plan, leaving the fallback to mandatory cuts as the only
resort.

These risks aside, most private sector forecasters envision growth
in 2012 approaching 2.5 percent. In the opinion of many economists, that
2.5 percent approximates the steady-state growth rate of the economy’s
potential. This rate would certainly be an improvement over 2011 as a
whole. The problem is without growth measurably better than 2.5 percent,
little progress will be made in absorbing slack in the economy-above
all, labor market slack.

Can the economy do much better than 2.5 percent in the coming
quarters? There are a number of reasons to be cautious about predicting
anything stronger than about 2.5 percent. For one, there is the
Reinhart-Rogoff thesis that economies recover very slowly following
severe financial crises. There is the prospect of fiscal drag continuing
at the state and local level along with the anticipation of sizeable
federal government spending cuts. There is the ongoing trend of
household deleveraging. And there is the weight of lower house values on
consumers’ spending. All this gives the economy a fragile feel.

Let me now return to the theme of uncertainty. Many have observed
that we are living in a world of “Knightian uncertainty.” That’s a term
named after University of Chicago economist Frank Knight, who examined
and distinguished between risk and uncertainty. The world he described
is one where the environment is not just risky, but one in which risk is
difficult to quantify. In such an environment, circumstances feel
unfamiliar and historical precedent provides little guidance. There is,
in such circumstances, acute uncertainty about the fundamentals of the
economy. This uncertainty compounds the difficulty of estimating the
likelihood of outcomes, a task that is challenging in the best of times.
I think this idea captures the feel of current circumstances, and may
well be a large part of the explanation for the disappointing
performance of the current recovery.

Glass half full?

So, in closing, I would offer the following thought with all
appropriate tentativeness and caveats. If the European situation is
stabilized and put on a believable resolution path, and if the
supercommittee delivers a believable fiscal plan accepted by Congress,
these two developments would go a long way toward clearing the air and
energizing economic activity.

In the meantime, I would simply point out that recent economic data
are mostly directionally positive and have mostly exceeded expectations.
Tom Sargent’s quote bears repeating for emphasis: “What’s going to
happen is going to depend partly on what you think is going to happen.”
A cautious mindset in the current environment is certainly warranted.
But as the numbers over the last couple of months demonstrate, outcomes
better than consensus expectations can happen. Let’s not talk ourselves
into believing that enduring weakness or recession is inevitable.

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

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