Black-Box Forecasting

For the past generation, Washington policymakers have based their economic projections on econometric models. Pioneered by Nobel Prizewinner Lawrence Klein of the University of Pennsylvania, the models are a series of equations that use past economic behavior as a guide to future business trends. Economists, for example, are able to predict the effects of a tax cut on new car sales.

Some of the Reaganauts, however, came into office wanting to do things differently. Instead of forecasts that use past behavior as the main standard, they based the economic outlook on how business would perform if everything worked out according to their theories. They put those assumptions into their computers, and the results were indeed impressive. Growth next year was to be 7%, and inflation would decline to 6.5% before falling to under 5% in 1985. By contrast, the Carter Administration had predicted 3.5% growth and 9.6% inflation for next year.

The Reagan Dream Machine was the work of Lawrence Kudlow, 33, former chief economist for the Wall Street investment banking firm of Bear, Stearns & Co., and John Rutledge, 32, head of the Claremont Economics Institute in Southern California.

Kudlow, who will soon be named chief economist of the Office of Management and Budget, insists that traditional econometric models are useless now because they do not measure the explosion of work and savings that will occur when President Reagan cuts taxes. Said Kudlow: "We have a new set of ideas, and a traditional model would merely serve to mislead and confuse the American people."

Other professional economists, however, claimed that it was Kudlow and Rutledge who were misleading people. M.I.T.'s Lester Thurow derided their whole approach on the ground that the two economists were asking people to accept their predictions without revealing how they had been calculated. Said he: "These numbers are being thrown out of a black box. Normally, whether it is a conservative or a liberal Administration, somebody has a chance to complain about the evidence, meet the people face to face, and argue about whether it's right or wrong. These two guys are throwing out projections without ever discussing their methodology." Charles Schultze, formerly Jimmy Carter's chief economist, called the Kudlow-Rutledge predictions "quite radical" and "wishful thinking."

Such grumbling finally had an impact.

Conventional economists within the Administration, led by Murray Weidenbaum, chairman-designate of the Council of Economic Advisers, reportedly argued that the Administration had to return to a more traditional econometric forecast or run the risk that its whole program might lose credibility. Last week Kudlow and Rutledge revised their figures and came up with more realistic projections. They now predict that growth next year will be 4%, while inflation will drop only to 8%. That is still too optimistic for many in Washington. Capital wags are now quipping that the highest-ranking woman in the new Administration is named Rosy Scenario.

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