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July/august
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The Battle for Energy Independence:
How Much of a Good Thing?
FEDERAL RESERVE BANK

The Auto Industry: Slowdown in
Sales, Stall in Jobs
Forecasting the Economy with
Mathematical Models:
Is It Worth the Effort?

business m h r

FEDERAL RESERVE BANK of PHILADELPHIA




IN THIS ISSUE . . .
The Battle for
Energy Independence:
How Much of a Good Thing?
. . . America's vulnerability to periodic oil
embargoes can be lessened, but the goal of
achieving energy self-sufficiency in the next
few years could cost more than it is worth.
The Auto Industry:
Slowdown in Sales,
Stall in Jobs
. . . As consumers curtail their purchases of
big-ticket items, a major casualty is the
automobile industry where the jobless rate
exceeds the overall national level.
Forecasting the Economy
With Mathematical Models:
Is It Worth the Effort?
. . . Econometric forecasting is a long way
from being an exact science, but prognos­
ticators can continue improving their models
by incorporating judgmental data and cor­
recting past errors.

On our cover: Of the historical houses in Philadelphia's Fairmount Park that are opened
to the public, Strawberry Mansion is the largest. It was once the home of U. S. District
Court Judge William Lewis, a friend of George Washington. In 1798 Judge Lewis built the
center section, naming the house Summerville. The wings were added in the mid-1820s
by a subsequent owner. The present name stems from the early 1840s when a resident sold
strawberries and cream to visitors. The furnishings of the mansion are Federal, Regency,
and Empire.
BUSINESS REVIEW > produced in the Department of Research. Editorial assistance is pro­
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vided by Robert Ritchie, Associate Editor. Ronald B. Williams is Art Director and Manager,
Graphic Services. The authors will be glad to receive comments on their articles.
Requests for additional copies should be addressed to Public Information, Federal Reserve

http://fraser.stlouisfed.org/ of Philadelphia, Philadelphia, Pennsylvania 19105. Phone: (215) 574-6115.
Bank
Federal Reserve Bank of St. Louis

The Battle for Energy
Independence:
How Much of a
Good Thing?*
By Tim othy H. Hannan

Abundant low-cost energy has been fun­
damental to the American way of life for a
long time. It's hard indeed to imagine
Americans without their climate-controlled
houses, aluminum cans, and large gasoline­
burning automobiles. Yet, as anyone who
cooled his heels in a gasoline line last year
can testify, a stable source of abundant lowcost energy can no longer be taken for
granted. Domestic demand for energy has in­
creased rapidly in recent years; domestic
supply has not. To help fill this widening gap,
Uncle Sam has relied increasingly on imports
from the Middle East, where a volatile
mixture of oil and politics has already re­
sulted in one serious embargo and poses an
ever-present threat of future embargoes.
As the recent gasoline lines and closed fac­
tories so dramatically demonstrated, a sud­

den curtailment of foreign oil can cause con­
siderable economic disruption in a nation
grown accustomed to relative energy abun­
dance. To reduce the threat of similar
economic disruptions in the future, the na­
tion has embarked on a policy of energy selfsufficiency. Government funds are being
allocated to stimulate research and develop­
ment of alternative sources of energy, volun­
tary conservation efforts are being pro­
moted, and— just to help voluntary conser­
vation along— tariffs are being imposed on
imported oil.
All of this brings up the question of the
desirability of these efforts and the degree to
which they should be pursued to bring about
energy self-sufficiency. As economists never
tire of proclaiming, resources are not limit­
less. The economy cannot at the same time
satisfy all desires for more goods and ser­
vices, higher quality environment, and great­
er reliance on domestic production of
energy. In the area of energy policy, this
means that hard choices must be made not
only among the various methods of reducing

*This article deals primarily with the economic issues
involved in seeking energy independence. Political or
diplomatic considerations also may be important in de­
termining the degree of energy self-sufficiency appro­
priate for the United States.




3

BUSINESS REVIEW

JULY-AUGUST 1975

Voluntary Conservation. In addition to ef­
forts designed to increase domestic energy
production, a reduction in dependence on
foreign sources of energy can also be
achieved by policies designed to reduce
domestic demand. Voluntary conservation is
a currently practiced example of such a poli­
cy, and it has met with at least limited suc­
cess. However, often self-interest and the
goals of voluntary conservation don't jibe. An
individual who believes his neighbors will
adequately conserve energy may find it in his
self-interest not to do so. Because of this
"free-rider problem," as economists often
call it, conservation on a voluntary basis is
generally recognized as having significant
limitations. For this reason, policymakers
have increasingly called for mandatory, and
perhaps less palatable, means of reducing
energy dependence.

energy dependence but also among the vari­
ous levels to which energy dependence
should ideally be reduced. Because re­
sources are scarce, complete energy selfsufficiency in the near future may come at a
very high price indeed.
ENERGY DEPENDENCE:
HOW CAN IT BE REDUCED?
Uncle Sam's arsenal contains many
weapons to combat the energy problem.
Most are designed to cut U. S. consumption
of energy, boost domestic production of
energy, or perhaps achieve some combina­
tion of thetwo. But as the current debate over
energy policy serves to emphasize, the vari­
ous methods of reducing energy depen­
dence are not identical, and much con­
troversy remains concerning the appropriate
path to follow. Consider a few of the more
important alternatives available.

Rationing.
Mandatory
conservation
through rationing is one such policy and has
in fact been proposed by a number of na­
tional leaders. The problems involved in de­
veloping an equitable rationing system,
however, are simply enormous. Decisions
would have to be made on how to allocate
gasoline, fuel oils, jet fuel, diesel fuel, and
many other refinery products to the
thousands of categories of consumers—a
function which, according to Treasury Sec­
retary William E. Simon, would require 15,000
to 20,000 full-time employees, incur $2 billion
in Federal costs, and require 3000 state and
local boards to handle the exceptions.2
Perhaps more important, rationing does not
provide the needed incentives for suppliers

Research and Development. Governmentfunded research designed to accelerate
development of alternative sources of
energy can play an important role in en­
hancing the nation's domestic production of
energy, particularly in the long run.1 The
future availability of low-cost energy from
nuclear, solar, and geothermal sources, or
from synthetic fuels and oil shale deposits,
may require substantial investments in re­
search and development. Although the
return to such investments may prove quite
significant, so too may be the time required
for these investments to pay off in the form of
abundant low-cost energy. Thus, research
and development of new technologies is
generally viewed as having only long-run
significance.

velopment may provide a large gain to the economy as a
whole, but there may be little opportunity for any one
firm to derive a large enough part of this gain to warrant
undertaking the research. Hence, Government partici­
pation in such efforts is needed.

’Although the private sector must be counted on to
undertake most of the energy research and develop­
ment, Government-funded research may prove to be
quite important. Development of new energy tech­
nologies often involves expanding basic knowledge of
fundamental processes. In such cases, research and de-




Statement of the Hon. William E. Simon, Secretary of
the Treasury, before the Ways and Means Committee of
the U.S. House of Representatives, January 22, 1974,
Department o f Treasury News, pp. 9-10.
4

FEDERAL RESERVE BANK OF PHILADELPHIA

and six-inch insulation remarkably “good
buys."
Second, unlike a policy of voluntary con­
servation or mandatory conservation
through rationing, the impact of the tariff in
reducing energy dependence is not limited
to that of simply discouraging consumption.
This is because a price rise brought on by the
tariff will also increase the incentives of
domestic producers to bring more energy to
the market. Economic rewards are important.
Faced with a rise in the price of energy, pro­
ducers of coal, oil, and other sources of
energy can be expected to search for and
develop additional sources. Energy deposits
identified by geologists but previously too
costly to work— such as the vast oil shale
deposits in Colorado and Wyoming— may
now be tapped simply because higher prices
make doing so profitable. And efforts to de­
velop new technologies in the production of
energy may be stimulated for the same
reason.
Thus, by raising the prices we must pay for
energy, a tariff on imported oil both reduces
domestic consumption of energy and in­
creases dorhestic production— making the
nation less dependent on foreign sources of
energy.

of domestic energy to increase domestic
production. Without new energy produc­
tion, rationing would continue to be needed
many years into the future.
The Tariff. Imposing a tariff on imported oil
is another tool available to policymakers. A
tariff is simply a tax placed on each unitor the
value of each unit of an imported good, and
its imposition on oil is designed to increase
the price paid for imported oil. Of major sig­
nificance is the tariff's effect on the price of
domestic oil. With the imposition of a tariff,
domestic oil becomes relatively more attrac­
tive to consumers of energy. As long as the
price of foreign oil exceeds that of domestic
oil, users will try to buy from domestic pro­
ducers. When this happens (and as long as at
least some domestic oil is not subject to Gov­
ernment price controls), the average price of
domestic oil will be bid up to a higher level.3
Because of the dual role of prices in dis­
couraging consumption and promoting pro­
duction, this whole process results in less
dependence on foreign energy sources.
First, the rise in the price of oil, both foreign
and domestic, will cause domestic purchas­
ers of energy to review their expenditures
and cut down on the more easily avoided
uses of energy. In the industrial sector, for
example, firms that did not consider energy
conservation measures worthwhile when
energy prices were low will now find it profit­
able to eliminate heat leaks, switch to less
energy-intensive technologies, or improve
waste-heat recovery systems. Consumers
who once drove large automobiles 30 miles
to work and failed to insulate their homes will
now find public transportation, small cars,

The Quota. Unlike the tariff, the quota re­
stricts imports in terms of quantities, rather
than in terms of a tax on each unit or on the
value of each unit. Its impact, however, is
quite similar. Like the tariff, the quota (by
directly reducing the supply of imported oil,
rather than by directly increasing its price)
causes an increase in demand for domestic
energy. Since a significant portion of domes­
tic energy production is not subject to price
controls, this means that the average price of
domestic energy will rise, performing the
dual function of discouraging domestic con­
sumption and encouraging long-run domes­
tic production. Thus, the quota, like the
tariff, provides policymakers with a doublebarreled weapon that can be used to make
the nation more self-sufficient in energy.

Governm ent price controls are currently in effect on
only a portion of domestically produced crude oil. In
applying price controls, a distinction has been made
between “ old oil" and “ new oil.” New oil isdefined as all
oil produced on a property in excess of output in the
same month of 1972. New oil and oil from wells produc­
ing less than ten barrels per day are not subject to price
controls. Domestic “ old oil," however, is currently
held at a price of $5.25 per barrel.




5

JULY-AUGUST 1975

BUSINESS REVIEW

tariff arrangements are designed to reduce
imports by either reducing domestic con­
sumption of energy, increasing domestic
production, or achieving some combination
of the two. But as some economists have

The tariff and the quota can differ in terms
of the revenue that they generate for the
Government or in terms of the predictability
of their economic impact (see Box 1). In gen­
eral, however, the similarities are more strikBOX 1

TARIFFS AND QUOTAS:
THE SIMILARITIES AND THE DIFFERENCES
The economic impact of tariffs and quotas can be quite similar. In fact, for any given
tariff, there is a theoretically equivalent quota. If supply and demand responses to price
changes are known with certainty, it is possible to predict the level of imports that will
result under a certain tariff and simply impose that quota to achieve the same result.
There are, however, some potential differences between the two means of restricting
imports. One potential difference is the revenue that they generate for Uncle Sam's
coffers. Since a tariff is a tax, it provides revenue for the Treasury as long as it doesn't
discourage all imports. But a quota is not a tax. It simply sets the level of imports allowed
into the country and therefore does not generally provide revenue to the Government.
Both means of restricting oil imports cause the domestic price to rise above the world
price, but the difference goes to the Government in the case of the tariff and usually to
the oil importers in the case of the quota. However, even this distinction can be
eliminated if, under a quota, the Government chooses to auction off import licenses. By
pursuing such a scheme, the Government could obtain roughly the same funds from
selling import licenses under a quota as could be collected under a tariff. With the right
conditions, both approaches can generate the same revenue.
A potentially more important difference between a tariff and a quota stems from the
fact that it is often not possible to predict future changes in supply and demand
conditions. Under these circumstances, tariffs and quotas thought to be the same can
have divergent results. For example, if world oil prices decline unexpectedly, a tariff will
result in an unexpected increase in the percentage of the domestic market supplied by
foreign oil, while a quota will not. Also, the failure of domestic supply to expand as
expected will lead under a tariff to an increase in imports, but under a quota it will cause
an unanticipated increase in the price of domestic oil. Because of uncertainty, the tariff
and quota can lead to unexpected and different results.
been pointing out, there are also ways to
soften those periodic blows from the Middle
East without significantly reducing overall
imports of oil, and a policy of oil storage
is perhaps the most frequently mentioned
example.
Storage performs the function of being an
alternate source of supply when the going
gets rough. By stockpiling oil bought from

ing than the differences. Both provide an in­
centive for domestic production, both dis­
courage domestic consumption, and, to
bring about these results, both require that
we pay higher prices for energy.
Oil Storage. Policies such as Governmentfunded research and development, volun­
tary conservation, rationing, and quota or




6

FEDERAL RESERVE BANK OF PHILADELPHIA

oil can be so severe in the short run, there
may be a positive gain from policies designed
to discourage imports gradually in the long
run. These long-run policies can cause the
economy to make adjustments without the
major disruptions associated with sudden
embargoes.
By cutting consumption, increasing pro­
duction, or stockpiling reserves, the country
can help protect itself from future embar­
goes. Of particular importance, the nation's
foreign and domestic policies do not have to
be unduly influenced by foreign producers
of oil.
But while there's something to be gained
from such policies, there are also significant
costs. Because resources are indeed scarce,
reducing the nation's vulnerability to foreign
oil embargoes requires sacrifice. If it is to be
achieved through increased domestic pro­
duction, large expenditures maybe required
for further exploration and for research and
development of alternate sources of energy.
If it is to be achieved by reducing domestic
consumption, money will have to be spent
on better insulation, more efficient engines,
and improved heat-recovery systems. More­
over, we will have to get along on less energy
consumption even when embargoes are not
underway. Tariffs and quotas also impose
these kinds of costs since they are simply
tools designed to increase production and
decrease consumption. And because they do
so by raising the price of energy, they also
bring about higher gas prices, higher heating
fuel costs, and higher prices of goods whose
production requires large amounts of energy.
Even an oil storage policy, which is not de­
signed specifically to reduce consumption or
increase production, may require consider­
able sacrifice in the form of large expenditures
on oil storage facilities.

foreign sources or by storing domestic oil in
the ground in the form of reserve capacity,
sudden shortages of imported oil can be par­
tially or totally filled by dipping into a
stockpile accumulated for just such a rainy
day. Oil storage, then, is another of the many
potentially useful steps that can be taken to
ensure a steady supply of energy.
REDUCING ENERGY DEPENDENCE:
THE GAINS AND THE COSTS
Clearly, there is a potential gain to all such
efforts designed to reduce the nation's vul­
nerability to oil embargoes.4 When the
spigots are turned off temporarily in the
Middle East the resulting economic disrup­
tions can cause considerable hardships. This
is because domestic supply patterns and
domestic consumption patterns cannot be
changed readily at a moment's notice. It
takes time to expand domestic energy pro­
duction and introduce expensive production
technologies which are not required when
Middle East oil is flowing freely. And on the
consumption side, it takes time to change
over to more energy-efficient applicances,
smaller automobiles, better-insulated build­
ings, and less energy-intensive technologies
in commerce and industry. Because of this
short-run inability to adjust to less energy,
sudden embargoes can mean production
bottlenecks, factory layoffs, cold homes, and
other hardships. Therefore, the advantage of
policies designed to avoid or reduce their
impact can be large. This can be true even of
policies such as a tariff or a quota, which are
designed to replace temporary curtailments
in imported oil with a permanent one. Be­
cause periodic sharp reductions in imported

4ln addition to avoiding or reducing the impact of
embargoes, policies designed to make the nation more
self-sufficient in energy can also help the balance of
payments problem, {However, since fluctuating ex­
change rates tend to correct imbalances in the balance of
payments, this advantage may not be a very significant
one.




THE QUESTION OF POLICY
As is the case with so many economic prob­
lems, hard choices must be made among
competing ends. To protect the nation from
7

JULY-AUGUST 1975

BUSINESS REVIEW

sufficiency even in the near future if we are
willing to pay the price for it. Imports of
foreign energy can be prohibited by quota,
extreme conservation measures can be im­
posed, or tariffs can be set high enough to
discourage all imports of oil, causing the
price of energy to rise until the domestic
supply of energy satisfies domestic demand.
(See Box 2.) All of this can be done, but is a
policy of energy self-sufficiency, carried to
this extreme, worth the costs? There are a
number of reasons to suggest that striving for
total self-sufficiency, at least in the near fu­
ture, may not be worth the sacrifice.

future oil embargoes, substantial sums may
have to be expended and hardships may have
to be endured. This means that the benefits
of reducing the country's vulnerability to
foreign oil embargoes must be weighed
against the costs of bringing about such a
result.
In such circumstances, economists often
apply a simple rule: increase the activity so
long as the additional gain that results ex­
ceeds the additional cost. In the present
case, this means that it is worthwhile to in­
crease activities such as research and de­
velopment efforts, oil storage programs,
tariffs or quotas, and conservation programs
only to the point where the additional gain
associated with insulation from embargoes
equals the increased costs of such efforts.
Beyond such a point, devoting more re­
sources to the effort simply will not pay.
Where this point lies is always difficult to
determine without further information.5This
framework, however, does establish the
probability that a number of policies de­
signed to reduce our vulnerability to foreign
embargoes— tariffs, research and develop­
ment, and oil storage, for example— may in­
deed be justified up to a point. But perhaps
more important, it can prove useful in analyz­
ing the desirability of a much publicized
goal—that of achieving complete energy
self-sufficiency.

Those Last Steps toward Self-Sufficiency.
One reason is that as the U. S. approaches
energy self-sufficiency, the cost of taking
such additional steps may increase, while the
advantage of making an already relatively
self-sufficient nation still more sufficient may
not be great. The additional costs are particu­
larly important. The nation moves toward
energy self-sufficiency by expanding domes­
tic production and reducing domestic de­
mand, but the further that either of these
activities are pursued, the greater will be the
sacrifice required. Expanding domestic sup­
ply in the near future will require that we turn
to increasingly costly methods of energy
production, and reducing domestic con­
sumption will require that increasingly high­
valued uses of energy be abandoned. The
sacrifice required to change the thermostat
from 75 to 65 degrees may not be great, but
that required by an additional 10-degree
twist of the dial may be substantial. It is for
these reasons that total energy self-suf­
ficiency, at least in the near future, may be
too much of a good thing. Put simply, the
gain from making those last steps toward
energy self-sufficiency may not be worth the
higher costs required to complete the trip. It
may be better to settle for something less.

COMPLETE ENERGY SELF-SUFFICIENCY?
To reduce the nation's dependence on un­
stable sources of foreign energy is one thing;
to eliminate it is another. This difference in
degree can be extremely important. It is no
doubt possible to achieve total energy self­

5On the one hand, if the probability of a recurrence of
last year's embargo is low, as many believe, then the
fruits of even the smallest efforts to reduce the nation's
vulnerability to foreign oil embargoes may not be worth
the cost. On the other hand, if the probability of recur­
ring embargoes is high, then substantial efforts may be
justified.




Risk-Free Sources of Foreign Energy. Not all
of the oil currently being imported into this
country comes from the politically volatile
8

FEDERAL RESERVE BANK OF PHILADELPHIA

BOX 2

THE "PRICE'' OF ENERGY SELF-SUFFICIENCY
A rough idea of the energy prices required to achieve energy self-sufficiency by 1980
can be obtained from a number of supply and demand estimates presented below.
ENERGY EQUILIBRIUM IN 1980
Millions of Barrels
of Oil per Day
Equivalent, at Prices Per
Barrel*
$7
$9
$11

Fuel
Domestic Supply
Crude oil and natural gas liquids
(including Alaskan)
Natural gas
Coal
Uranium and hydroelectric
New technology
Total Supply
Domestic Demand
Net imports

10.6
(2.0)
14.7
6.1
5.2
0.0
36.6
44.2
7.6

10.7
(2.0)
14.5
8.0
5.2
0.0
38.4
42.4
4.0

10.9
(2.0)
14.4
8.0
5.2
0.1
38.6
40.6
2.0

SOURCE: Energy Self-Sufficiency, An Economic Evaluation (Washington:
American Enterprise Institute for Public Policy Research, 1974),
p. 8.
*A fuel is made "oil equivalent" by finding the number of barrels of oil which
has the same heating value as a given quantity of that fuel.

These estimates, which were derived from a number of statistical studies, indicate the
supply of different fuels and the total domestic demand for energy that can be expected
at the prices of $7, $9, and $11 per barrel (in constant 1973 dollars). As economic theory
would suggest, higher prices mean more energy will be produced domestically and less
of it will be consumed.
But here is where part of the problem of energy self-sufficiency emerges. As should be
noted from the Table, the expected supply of various types of energy in 1980 is relatively
unresponsive to price increases. In addition, the reduction in domestic demand for
energy that can be expected to result from a price increase is estimated to be quite small.
This means that in order to reach the point at which domestic supply equals domestic
demand, which is required if no energy is to be imported, we may have to pay prices
significantly higher than $11 per barrel (in constant 1973 dollars). As can be seen, this is
significantly higher than the price of energy that would be required if we relied on some
imports.




9

BUSINESS REVIEW

IULY-AUGUST 1975

Middle East. Much comes from countries that
are less likely to institute embargoes. A suffi­
ciently restrictive policy can eliminate im­
ports from relatively secure sources just as
well as it can eliminate those from insecure
sources. But why bear the cost if little is to
come out of it? The primary gain from reduc­
ing imports is the reduction in periodic dis­
ruptions resulting from embargoes, but if a
source of supply is relatively secure, there is
little reason to incur the higher costs re­
quired to eliminate such imports. This means
that policies should be less restrictive toward
secure sources of foreign energy than those
required by insecure sources— yet another
reason to question the advisability of total
energy self-sufficiency.

part of the gain from reducing imports is the
resulting reduction in the economic impact
of embargoes. But if a storage policy is insti­
tuted, embargoes become less serious, thus
reducing the gain to be obtained by eliminat­
ing all oil imports. This does not necessarily
mean that all efforts to increase energy selfsufficiency should be abandoned in the pres­
ence of a storage policy. Some movement
toward self-sufficiency may still be justified.
However, it does provide yet another reason
to question the goal of independence from
all sources of foreign energy.
CONCLUSION
Uncle Sam's arsenal contains many
weapons that can be used to reduce the na­
tion's vulnerability to periodic oil embar­
goes. Some, such as voluntary conservation
programs and mandatory conservation
through rationing, are designed to reduce
domestic consumption. Others, such as ef­
forts to develop alternative sources of ener­
gy, are designed to increase domestic pro­
duction. Still others, such as oil storage
policies, are designed to soften the blow of
periodic embargoes without significantly re­
ducing overall imports. Because all are cost­
ly, however, a proper balance must be struck
between the gains and costs resulting from
their use. Reducing the nation's vulnerability
to a sudden oil embargo is important, but so
too are the substantial sacrifices required to
do it. Since periodic oil embargoes can cause
serious economic disruptions, it may well
pay to reduce our dependence on foreign
sources of energy, at least to a degree. But
running the full distance to achieve total
self-sufficiency in the next few years may
simply not be worth the cost required.
S

Oil Storage. If the goal of complete energy
self-sufficiency means eliminating all oil im­
ports, then the advantage of oil storage
policies is another reason why the goal may
not be desirable. If the cost of storing oil and
using it during embargoes is not excessive, it
may well pay to store at least some oil to
smooth out the disruptions when they oc­
cur.6
But if a policy of oil storage is undertaken,
what does this mean for the goal of selfsufficiency? Simply stated, it reduces the
need to eliminate all imports. A substantial

6Storage can take the form of either increasing domes­
tic reserve capacity or stockpiling oil purchased abroad.
The question of whether reserve capacity or storage
from foreign sources is better is a simple cost calcula­
tion. If the landed price of foreign oil plus storage is less
than the incremental cost of developing domestic capac­
ity, then storage of foreign oil is preferable, and vice
versa.




10

The Auto Industry:
Slowdown in Sales,
Stall in Jobs
By Clara Prevo
GHART

1

CONSUMERS HAVE RECENTLY SEEN THEIR INFLATION-ADJUSTED
SPENDING POWER DROP . . .
Billions of Constant (1958) Dollars

Disposable Personal Income
625
600
575
550

—

i

*
i

SO U RC E:




II

III
IV
I
II
III
1973
1974
(Annual Rate Seasonally Adjusted)

U. S. Department of Commerce.

11

IV

I
1975

BUSINESS REVIEW




JULY-AUGUST 1975

CHART 2
AND THEY RESPONDED IN PART BY CUTTING BACK ON THEIR
PURCHASES OF DURABLES.

12




FEDERAL RESERVE BANK OF PHILADELPHIA

13

BUSINESS REVIEW




JULY-AUGUST 1975

CHART 4
WHICH HELPED PUSH THE JOBLESS RATE IN THAT INDUSTRY
ABOVE THE OVERALL RATE.
Percent

J F MA MJ J A S O N D J
1973
SO U RC E:

F M A M J J A
1974

S O N D J

U. S. Department of Labor, Bureau of Labor Statistics.

14

FM
1975

Forecasting the
Economy with
Mathematical
Models: Is It
Worth the Effort?
By Nariman Behravesh

The months following the Arab oil em­
bargo of 1973-74 could well go down in his­
tory as the nadir of the art and science of
economic forecasting. The embargo, oil
price increases, and the ensuing recession
jarred the U. S. economy, leaving economists
with forecasts that were in many cases em­
barrassingly wrong. For example, errors as­
sociated with price level and real GNP predic­
tions as much as tripled after mid-1973.1
Quite a comedown for those who in earlier
years had earned high marks for forecasting!
On average, forecasters who keyed their
predictions only to mathematical or econo­
metric models were proved less accurate
than those who relied on pure judgment

or a combination of judgment and econo­
metrics.2 The quality of the forecasters'
judgment helped to determine the relative
accuracy of economic predictions duringthis
period. Less clear-cut, though, is the degree
to which econometric models helped or hin­
dered those who used them.
Some skepticism about econometric fore­
casting is clearly justified. Mathematical
models are still in their formative stages.
When used to forecast the economy, they
tend to underestimate the peaks (high
points) and troughs (low points) in business
cycles and to miss the timing of these busi­
ness cycle turns. Yet, most forecasters using
econometric models can compensate for

1See Stephen K. McNees, "How Accurate Are
Economic Forecasts?" New England Economic Review of
the Federal Reserve Bank of Boston, November/
December 1974, pp. 2-19.

2lbid. A judgmental forecast is formulated without the
help of an econometric model but depends on a variety
of inputs including the forecaster's intuition, trend pro­
jections, and the use of leading indicators.




15

JULY-AUGUST 1975

BUSINESS REVIEW

large extent, these internal variables may in­
fluence each other. For example, GNP is di­
rectly related to national income, which in­
fluences consumers' expenditures on goods
and services, which in turn helps to deter­
mine GNP. However, these internal variables
also depend on other variables such as Gov­
ernment expenditures, exports, tax rates,
and lending rates of central banks— some of
which may not be determined purely by
economic forces. These variables can be
called external variables because they are not
explicitly determined by the model.3 A
forecaster intending to use a model to pre­
dict economic activity must supply the pre­
dicted values for these external variables.

weaknesses inherent in the models. These
models are invaluable for zeroing in on the
effects of policy changes on the economy.
Moreover, since considerable research in
empirical economics is being directed at
refining these models, forecasters will
probably find them increasingly useful aids
for prognostication.
INSIDE A PANDORA'S BOX
An econometric model used by a forecast­
er is a set of mathematical and statistical rela­
tionships that purports to describe economic
behavior. These models are based on eco­
nomic theory and, in the process of model­
building, the relationships in the models are
estimated and tested using the historical
data (see Box).
Most econometric models used in predict­
ing the status of the economy are quite large
(40 to 400 equations). These so-called macroeconometric models are designed to pre­
dict economic variables such as the Gross
National Product, the price level, the un­
employment rate, and interest rates. Such
variables, which are determined within the
model, can be called internal variables. To a

determination of whether a variable is internal or
external to the model depends on its builder. For exam­
ple, some model builders may designate Government
expenditures as an external variable since these expen­
ditures are determined by a number of noneconomic
forces that the model cannot consider. Other model
builders may feel that Government spending depends
primarily on economic activity and, therefore, should be
included among the internal variables and described
explicitly by the model. Econometric models must al­
ways have some external variables; otherwise, the
forecaster faces an everything-depends-on-everythingelse situation.

ANATOMY OF AN ECONOMETRIC FORECAST
Building a Model. If we were interested in building an econometric model our im­
mediate questions would be: What economic variables do we want to describe? What
does economic theory have to say about these variables? What does the data show about
these variables? Here is how these questions may be answered.
Suppose, for example, we want an overall description of consumption behavior in the
U. S. economy. A review of relevant economic theories might turn up this assertion:
Aggregate consumption is related to disposable or after-tax income. If the data for
consumption and disposable income were graphed (see Diagram), the scatter of points
would lie nearly on a straight line with a slope of about nine-tenths. Then it could be said
that on average in the U. S., nine-tenths of disposable income is used for consumption
expenditures.* In mathematical terms, this relationship would be:
Consumption = .9 x Disposable income.
*The consumption relationship being described is a long-term one. The distinction between long- and
short-term consumption will not be made in the interests of simplicity.




16

FEDERAL RESERVE BANK OF PHILADELPHIA

RELATIONSHIP BETWEEN CONSUMPTION AND
DISPOSABLE INCOME.
Consumption
600

Billions of Dollars (1958)

500

400

300

200
’35

100

'«

^?30

|
200

300

400

500

600

Disposable Income

Notice that this simple relationship is not an exact one. For example, in the Depres­
sion and war years, consumption was less than nine-tenths of disposable income (that
is, in the Diagram, the observations for these years fall below the line). The opposite is
true for the '60s. The inexactness of this simple model can be traced to factors such as
changes in wealth, depressions, and wars that have not been taken into account. The
model builder can rewrite the consumption equation to account for the approximate
nature of the model:
Consumption = .9 x Disposable income + Error
"Error" refers to all the factors that affect consumption which the modef builder has not
taken into account. By includingsomeof these factors in the consumption equation, the
size of the error can be reduced.** If this consumption model were used for forecasting,
**lf more han one explanatory variable is used to describe consumption, plotting the data and fitting a line
as we have done in Chart 2 would be difficult. However, there are statistical methods that can do the same
thing.




1
17

BUSINESS REVIEW

JULY-AUGUST 1975

the reduction of this error would be a step toward more accurate forecasts.
Another salient characteristic about the scatter of points in Chart 2 is that if consump­
tion is below average (that is, below the line) in a particular year, then it is likely that it
will be below average for a few years (the war years). The same is true when consump­
tion is above average (the '60s). This tells us that consumption patterns vary slowly in
response to changes in the economy— that is, the "error" or unexplained portion of the
consumption model is not random. In fact, this error is systematic and correlated with its
past and future values (econometricians referto this type oferroras serially correlated).
Systematic or serially correlated errors are common in macroeconometric models and
should be taken into account when these models are used for forecasting.
Forecasting with a Model. An econometric forecast is obtained by projecting the
estimated model to include the year or years of interest. Suppose we were interested in
predicting consumption expenditures in the United States in 1974 and 1975. If it were
known that disposable income in those years was $650 billion and $750 billion (mea­
sured in 1958 dollars), respectively, then the simple model introduced above could be
used to forecast consumption. This model would predict consumption in 1974 and 1975
to be $580 billion and $630 billion, respectively (also measured in 1958 dollars).
Such forecasts are approximate, since by ignoring the other factors that affect con­
sumption in the simple model, these factors are ignored when this model is used to
predict consumption. Sharp-eyed forecasters would have to decide if there were any
factors that would induce more or less consumption in 1974 or 1975. For example, if it
were expected that economic activity was slower than usual in these years, then con­
sumption would also be subpar; therefore, we would want to adjust the predicted
consumption levels downward. In this way we would be able to consider the "other
factors" which affect consumption and which the simple model does not take into
account. A more sophisticated forecaster would weigh the possibility that if consump­
tion fell below average in any one year it may remain there in the following years (that is,
economic variables may move slowly through time). To compensate, we would adjust
consumption downward for a greater time. Thus, an econometric model tempered by
the forecaster's judgment can yield better forecasts.
Multiequation Models. The model presented above has a number of shortcomings.
From a behavioral point of view, it is a simplistic model of consumption. From a
forecasting point of view, this single-equation model depends on forecasts of dispos­
able income, which may be just as difficult to predict as consumption expenditure.
Furthermore, disposable income is influenced by the level of consumption in the
economy (since consumption contributes to GNP, which is directly related to dispos­
able income). These types of problems are usually solved by adding more equations to
the model.
Just as consumption forecasts required us to supply predictions of disposable income
in the above model, forecasts of the internal variables of a large econometric model
(such as GNP, prices, and unemployment) require predictions of the external variables
(such as Government expenditures, taxes, and the money supply). Furthermore, in the
same way that the consumption forecasts above could be modified to account for
information not already included in the models, adjustments can be made to the
forecasts of large econometric models.




18

FEDERAL RESERVE BANK OF PHILADELPHIA

THE CYCLES PRODUCED BY AN
ECONOMETRIC MODEL
The value and reliability of macroeconometric models in forecasting business cycles
can be studied in two ways. The first method
compares the actual historical values of key
internal variables such as real GNP with the
values a forecaster would have obtained from
the model. This method provides insight into
the model's ability to duplicate the economic
conditions which occurred, when it is sup­
plied with the actual historical values of
the external variables. The second method
compares the size and duration of fluctua­
tions for a predicted variable, such as real
GNP, with the actual business cycle fluctua­
tions of that variable. Such a comparison
would allow the forecaster to judge the
reasonableness of the business cycles pro­
duced by the model when he has to rely on
forecasts of the external variables. The model
under scrutiny here represents the state of
econometric model-building in the late
1960s.
Chart 1 compares the actual values of real
GNP from 1956 to 1965 with a historical fore­
cast of real GNP by an econometric model.4
The predicted values rise and fall at about
the right time but don't trace out the cycles
in real GNP very well. In fact, these forecast
values underestimate both the peaks and
the troughs in the actual series. One explana­
tion for this difference may be that the
peaks and the troughs in the actual series
were caused by unanticipated occurrences
that the model was not "smart" enough to
capture. These unanticipated events or

"shocks" may have consisted of major
strikes, changes in international markets, or
shifts in Government policies that were not
explicitly built into the model.
The second method of analyzing the
"tracking" record of an econometric model
— looking at the long-run forecasts it gen­
erates— yields similar conclusions. Fore­
casters wishing to make long-run predic­
tions must begin by predicting the long-run
changes in the external variables.5As a result,
these long-term forecasts are no more accu­
rate than the predictions of the external vari­
ables supplied by the forecaster. For lack of
better information, long-run forecasters
usually assume that external variables will
change slowly and with virtually no fluctua­
tions. However, this implies thatthe long-run
forecasts generated by an econometric
model may also be fluctuation-free (Chart
2— dashed line). Clearly, such forecasts do
not trace out anything resembling a business
cycle.
More realistic cycles can be traced by
econometric models if the modeler tries to
account for the occurrence and impact on
the economy of events such as wars, strikes,
and embargoes. One way of doing this is to
impose random shocks on the models (Chart
2 — dotted line). But these cycles are too fre­
quent and short-lived compared to an actual
series such as in Chart 1. These cycles are too
short because the model moves the economy
back to a "normal" position immediately
after the shock is felt. However, in reality, the
economy often takes more time to adjust to
such disruptions. If the model user spreads
the impact of these shocks over a number of

“
•Historical, or after-the-fact, forecasts used in the first
method of analyzing the tracking record of econometric
models require that the user provide values of the exter­
nal variables of the models (such as Government expen­
ditures, taxes, and exports). In these forecasts the
external variables are set at their actual historical values.
Data for these external variables are fed into an econo­
metric model which then predicts the values of internal
variables such as real GNP, prices, and unemployment.

Unfortunately, usable forecasts of the external vari­
ables may be as difficult to get as predictions of the
internal variables. Short-term forecasts of variables such
as Government spending, taxes, and money supply
growth may be easily obtained through Government
budget estimates and other sources. However, getting
accurate long-run forecasts of such external variables is a
tougher undertaking. This, in turn, undermines the ac­
curacy of all long-term forecasts, both econometric and
judgmental.




19

BUSINESS REVIEW

JULY-AUGUST 1975

CHART 1
MODELS TEND TO UNDERESTIMATE THE ACTUAL PEAKS AND
TROUGHS OF A BUSINESS CYCLE.
Billions (1958 Dollars)

SO U RCE:

B. G. Hickman, e<±, Econometric Models of Cyclical Behavior
(New York: National Bureau of Economic Research, 1972).

periods, the fluctuations in the predicted
series are smoother and begin to resemble
the actual fluctuations in the series. (Com­
pare the solid line in Chart 2 with the actual
series in Chart 1.)
Accordingly, model users must be wary of
the fact that business cycles produced by
econometric forecasts are less pronounced
than those the economy normally experi­
ences.6 In part, this may be a result of the

inability of the models to foresee and, there­
fore, cope with the impact of unanticipated
events, especially those whose impacts are
spread over a number of periods. Fortunate­
ly, judicious use of judgmental information
can at least partially compensate for such
model weaknesses.
fore, cannot duplicate business cycle behavior. On the
other hand, econometric models may be good represen­
tations of the economy if, indeed, business cycles are a
result of shocks to an economy which would otherwise
be stable. It can then be argued that no matter how good
a model is, it will inevitably fail to predict some unantici­
pated shocks and, consequently, miss some business
cycle fluctuations.

6
The smoothness of econometric forecasts relative to
economic time series may be explained in two different
ways. On the one hand, econometric models may not be
good representations of economic structure and, there-




20

FEDERAL RESERVE BANK OF PHILADELPHIA

CHART 2
LONG-RUN FORECASTS OF REAL GNP WITH AND WITHOUT SHOCKS.
Size of the Variable

1975
SO U RC E:

1980

1985

B. G. Hickman, ed., Econometric Models of Cyclical Behavior
(New York: National Bureau of Economic Research, 1972).

THE TRACKING PERFORMANCE OF SOME
MODELS

clues as to their ability to track past business
cycles.8 Although these models have
*
changed significantly since 1969, the state of
the art has probably not changed enough to
make the types of results presented here ob­
solete.

How accurately have forecasters relying
solely on some of the major econometric
models been able to spot the timing and
magnitude of business cycle turns?7A look at
the 1969 versions of three models which
make quarterly forecasts provides some

“VictorZarnowitz, Charlotte Boschan, and Geoffrey H .
Moore, “ Business Cycle Analysis of Econometric Model
Simulation," in B. G. Hickman, e d ., Econometric Models
o f Cyclical Behavior (New York: National Bureau of
Economic Research, 1972), pp. 311-541. The models
considered in this study are the Wharton Econometric
Forecasting Unit m odel, the O ffice of Business
Economics model, and the MIT-Penn-Fed model.

7Aturning pointinthe business cycle occurs when the
economy shifts from a positive growth period to a nega­
tive growth period and vice versa. The former points are
called peaks and the latter troughs in the reference-cycle
terminology of the National Bureau of Economic Re­
search.




21

BUSINESS REVIEW

JULY-AUGUST 1975

Spotting the Turning Points. Table 1 sum­
marizes the accuracy with which these three
models were able to predict the timing of
turning points for six-quarter historical fore­
casts.9 On average the historical forecasts
spotted a turning point two-thirds of the time
when the economy actually peaked or bot­
tomed out. There did not seem to be a ten­
dency on the part of the models to predict a
turning point when one did not occur.
The models tended to predict turns too
soon. This is especially true for historical
forecasts that preceded the turning point by
three quarters. The closer the turning point
to the start of the forecast period, the better
the chance of calling the turn. These results
did not differ for upturns or downturns.

In order to correct such errors, it would
help if the forecaster could pinpoint some
of their sources. The forecasting mechanism
of business cycles in many quarterly models
is linked to investment and inventory cycles,
both of which are leading indicators in
business cycles.1 However, investment and
0
inventory cycles are not the only factors that
account for business cycles in the economy.
It is entirely possible that model builders
haven't fully accounted for the complex
linkages between such leading indicators
and the economy. Generally, the closer the
turning point, the more useful and reliable
the information that signals the turn will be to
the model. So, the closer the forecast is
to the turning point the greater is the likeli­
hood that the model will correctly spot the
cycle peaks and troughs. In general, a

9A six-quarter historical forecast starting, for example,
three quarters ahead of the turning point, would begin
nine months before the quarter in which the turn occur­
red and would end six months after the quarter of the
turn. It should be remembered that for a historical fore­
cast the external variables are set to their actual historical
values.

10Leading indicators are economic variables that will
usually peak before the economy peaks and bottom out
before the end of a recession. These indicators are iden­
tified and classified by the National Bureau of Economic
Research.

TABLE 1

HOW THREE MODELS* SPOTTED TURNING POINTS:
1957-61**
Too Soon

Too Late

On Time

43%

26%

31%

37

28

35

28
36

Average of Forecasts Starting 3 Quarters
Ahead of Turning Point
Average of Forecasts Starting 2 Quarters
Ahead of Turning Point
Average of Forecasts Starting 1 Quarter
Ahead of Turning Point
Average of All Forecasts

33
29

39
35

*The three models in question are the 1969 versions of the Wharton, Bureau of Economic Analysis, and
MIT-Penn-Fed models.
**Victor Zarnowitz, Charlotte Boschan, and Geoffrey H. Moore, “ Business Cycle Analysis of Econometric
Model Simulations," in B. G. Hickman, ed., Econometric Models o f Cyclical Behavior (New York: National
Bureau of Economic Research, 1972), pp. 311-541.




22

FEDERAL RESERVE BANK OF PHILADELPHIA

TABLE 2

HOW THREE MODELS* FARED IN PREDICTING THE SIZE OF
PEAKS AND TROUGHS: 1957-61**
Too Large
Average of Forecasts Starting 3 Quarters
Ahead of Turning Point
Average of Forecasts Starting 2 Quarters
Ahead of Turning Point
Average of Forecasts Starting 1 Quarter
Ahead of Turning Point
Average of All Forecasts
Average of Forecasts during Contractions
Average of Forecasts during Expansions

Too Small

Correct

21%

54%

25%

15

62

23

15
17
14
21

55
57
57
56

30
26
29
23

*The three models in question are the 1969 versions of the Wharton, Bureau of Economic Analysis, and
MIT-Penn-Fed models.
**Zarnowitz, Boschan, and Moore, “ Business Cycle Analysis of Econometric Model Simulations/' in
Hickman, ed., op. cit., pp. 311-541.

modeler must assume that short-run fore­
casts are more accurate than longer-run
ones.

predict a turning point too soon. If the mod­
els called a peak or a trough too early, then at
the peak or trough the predicted series
would underestimate the actual rise or de­
cline that occurred. Undershoots can also
result because the models ignore the
cumulative effect of the "other factors" that
are overlooked in the model structure. Here
again, the closer the starting point of the
forecast to the actual turning point, the bet­
ter and more plentiful the information signal­
ing the turn, and so the more accurate the
forecasts.

Predicting the Size of Peaks and Troughs. The
Achilles heel of many macroeconometric
models is their proclivity to smooth out busi­
ness cycles and, in so doing, undershoot the
size of both peaks and troughs. The three
models under consideration did, in fact,
smooth over past cycles (see Table 2). These
models tended to underestimate both peaks
and troughs. The closer the beginning of the
forecast was to the actual turn, the better the
chance the models had of correctly predict­
ing the size of a peak or trough. On average,
the models were better at foretelling the
depth of the slide during a recession than
they were at gauging the peak to which the
economy rose before experiencing a con­
traction.
Models undershoot the size of the peaks
and troughs for several reasons. In part, this
may be a result of the model's tendency to



SHARPENING THE FORECASTS
On the whole, this evidence suggests that,
without adjustments by the forecaster, the
tracking record of econometric models
leaves some room for improvement. There
are two general ways to hone the tracking
and predictive abilities of econometric mod­
els. The first is numerically adjusting an exist­
ing model prediction to correct for past
23

JULY-AUGUST 1975

BUSINESS REVIEW

misses and to impose the forecaster's judg­
ment. The second strategy is refining and im­
proving the model itself.
Forecasters can improve their results by
anticipating and mathematically correcting
the tendencies of the models to smooth out
economic fluctuations. This can be ac­
complished by looking at past error patterns
(that is, the difference between the actual
and the predicted series, such as in Chart 1),
and adjusting the forecast to compensate for
these errors. If, for example, a model tends
to understate GNPgrowth during expansions
and to overstate GNP growth during contrac­
tions, the model user can adjust GNP growth
predicted by a model upward or downward
to counteract this tendency. A great deal was
learned about this process and about
econometric models from the larger than
usual forecasting errors made in the months
right after the Arab oil embargo.
Most econometric forecasters will also use
their judgment to anticipate the impact on
the economy of events they expect to occur.
This information is then used for the neces­
sary adjustments to the forecast. For exam­
ple, during the Arab oil embargo economet­
ric forecasters tried to estimate the effect of
the boycott on production and consumption
activities and to fine-tune their models cor­
respondingly.1 The virtue of econometric
1
models is that these adjustments are fed
through the model so that an embargo's im­
pact on the economy can be measured. Thus,
correction of past error patterns and imposi­
tion of informal judgment on econometric
models should, in general, yield better fore­
casts.
The second method of improving
econometric forecasts, which entails chang­
ing the structure of the model and updating
it, could also result in improved forecasts.
Econometric forecasts can be refined by try­

ing to incorporate other types of predictive
information, such as anticipatory data, into
the models. For example, a recent study has
shown that incorporating the plant and
equipment investment anticipations of the
Bureau of Economic Analysis into a model
can reduce the forecasting errors of
business-fixed investment.1 To a lesser de­
2
gree, incorporation of the University of
Michigan's consumer sentiment index into a
model will improve consumer expenditure
forecasts. Including this anticipatory data
also improves the ability of models to predict
turning points.
Still another way of upgrading the overall
performance of econometric models entails
"reestimating" the models continuously by
adding new observations to the data base and
recalculating the equations used for predic­
tion. Most macroeconometric models that
are used commercially are reestimated every
three to five years. Given their size, rees­
timating them more often is costly and im­
practical. Nevertheless, within a three- to
five-year period institutional and behavioral
changes in the economy could possibly in­
validate part of the model. For example, the
high rates of inflation in 1974 may have al­
tered economic behavior. Econometric
models which were estimated before then
would have missed this change. Small mac­
roeconometric models can be reestimated
every quarter when national income data are
released. However, this type of reestimation
alone is not sufficient to reduce significantly
the forecasting errors of the models. Up­
graded econometric forecasting requires ad­
justing the model by employing judgment
and the analysis of past errors.
Finally, some research in economics is
being directed at improving the structure of
the models and at using economic data more
efficiently in estimating and quantifying

"See Donald L. Raiff, "Forecasting in a 'Shortage'
Economy," Federal Reserve Bank of Philadelphia, 1974
(unpublished paper).

12F. Gerard Adams and Vijaya G. Duggal, "Anticipa­
tions Variables in an Econometric Model: Performance
of the Anticipations Versions of Wharton Mark III," In­
ternational Economic Review 15 (1974): 267 - 83.




24

FEDERAL RESERVE BANK OF PHILADELPHIA

policy menus for economic policymakers. It
is relatively easy for an econometric model to
provide a range of forecasts made under a
variety of policy assumptions. As the impact
of changes in Government expenditures and
the growth in the money supply are traced
through the model, the policymaker can de­
termine the effect of various policies on the
economy.
Finally, once a large econometric model
has been built, it can be employed for pre­
dicting a multitude of economic variables
with a small expenditure of time and effort.
For example, some current models regularly
predict as many as 400 variables. The
judgmental forecasting of the same number
of variables, on a regular basis, may be very
time-consuming.

these models. It is likely that functional rela­
tionships can be discovered and refined
which will allow modelers to predict specific
internal variables more precisely.
WHY USE ECONOMETRIC MODELS AT ALL?
Although econometric models, on their
own, cannot track business cycles very well,
they do provide an explicit and wellorganized framework within which the
forecaster can apply judgment to improve
their predictive ability. Judgmental forecast­
ers have some implicit model of economic
behavior in mind to rely on in formulating
their predictions. However, such models are
rarely made public along with the judgmental
forecasts. The advantage of econometric
models is that one can readily pinpoint and,
therefore, try to correct weaknesses in the
model structure and the assumptions under­
lying the forecast.
Another important advantage of econo­
metric models is the way in which adjust­
ments feed through the entire model to
provide forecasts that are, at all times, con­
sonant with forecasters' theories of how the
economy is structured. Obtaining consistent
forecasts under a variety of assumptions is
more difficult for a judgmental forecaster be­
cause the relationships between economic
variables in a judgmental "model" are not as
clearly defined as those in an econometric
model.
Econometric models also help serve up




CONCLUSION
Pure econometric forecasting does not
provide very accurate predictions of the tim­
ing, size, and duration of business cycles.
This is especially true for longer-run econo­
metric forecasts. Nevertheless, forecasters
who adjust these models to impose judg­
mental information and to correct model
errors can substantially improve their
accuracy. Furthermore, flexibility and con­
tinued improvements of econometric fore­
casting relative to judgmental forecasting do
make the efforts channeled into econometric
model-building and predicting worthwhile.

25

BUSINESS REVIEW

JULY-AUGUST 1975

ECONOMICS
INFLATION
Inflation is currently a major problem
facing the U.S. Can policymakers
curtail it? If so, how much will their
actions "cost" society? Is inflation
"bad," and if so, why? Are there
ways of "living with inflation" that
cushion its negative impact on the
individual and society? Six articles
reprinted from the Philadelphia
Fed's Business Review
these questions in det£
seek to promote an
understanding of the
problem for both
policymakers
and the general
public.
Copies are available free of charge. Please address all requests to Public Information,
Federal Reserve Bank of Philadelphia, Philadelphia, PA 19105




FEDERAL RESERVE BANK OF PHILADELPHIA

On December 31, 1974, Americans were permitted to buy and sell gold for the first
time in some 40 years. Since then questions have been raised about the once-hallowed,
almighty metal's worth and importance. For example, has its status in the United States
and in the international monetary system changed? If so, in what manner? A pamphlet
recently produced by the Philadelphia Fed's Department of Public Information con­
siders the role of gold— past, present, future.
Copies are available free of charge. Please address all requests to Public Services,
Federal Reserve Bank of Philadelphia, Philadelphia, PA 19105.




riDKRAL RESERVE B N
A

3

riDIRAL RESERVE BANK

FEDERAL RESERVE BANK of PHILADELPHIA
PHILADELPHIA, PENNSYLVANIA 19105

business review
FEDERAL RESERVE BANK
OF PHILADELPHIA
PHILADELPHIA, PA. 19105