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December 15, 1994

Federal Reserve Bank of Cleveland

Year-End Report of the Fourth
District Economists' Roundtable
by Michael F. Bryan and John B. Martin

.lthough economists share a common science, their roles in society vary a
great deal. Academic economists expand
our understanding of the purpose and
operation of markets. Government economists use this knowledge to guide policies. And business economists apply
these principles to enterprise.
Perhaps because of these vastly different
roles, the bridges that link economists in
disparate fields can be narrow and far
apart. Yet each discipline depends on the
other. Business economists need to be
exposed to the frontiers of economic
thought and to keep abreast of government policies that influence their companies. Academics must evaluate the conformity between theory and evidence.
And government economists are called
on to synthesize the sometimes abstract
thoughts of academics and the practical
considerations of business.
In this spirit, the Federal Reserve Bank of
Cleveland hosts the Fourth District Economists' Roundtable, a thrice-annual meeting of business economists. Through
these encounters, we hope to consider
innovative and potentially useful ideas in
academic research, to discuss issues
regarding the economic outlook, and to
provide a forum for participants to critique the conduct of monetary policy.
This Economic Commentary is a summary of the group's November 3 meeting.


The Economic Outlook

At its May 20 meeting, the Roundtable
projected that the economy would
strengthen from its 2Vi percent firstquarter growth rate to 2>Vi percent in
1994:IIQ. After that brief spurt, the panelists expected growth to moderate, with
output rising about 3 percent in the third
quarter and then leveling off at around
2% percent through the end of 1995.
The view at that time was that after a
final burst in production spurred by
investment spending, particularly on
business equipment and consumer
durables, the economy would gradually
slow to its potential growth rate.
The actual GDP numbers proved to be
somewhat better than that projection,
with output rising 4.1 percent and 3.9
percent in the second and third quarters,
respectively. To some, this indicated that
the economy had a bit more room to
expand before it was pushed to its production limits. To others, it warned that
we had entered a zone of overcapacity
production — an area where it is presumed that inflationary pressures begin
to percolate.
At its November caucus, the Roundtable
continued to project a significant slowing
in the pace of business activity, and for
essentially the same reasons as stated last
May: There comes a point in every expansion when resources become fully
employed and the economy naturally
loses steam (figure 1). The median view
of the 18 panelists is for real GDP to

At its final meeting of 1994, the
Fourth District Economists' Roundtable projected that real GDP will
moderate slightly this quarter and
into 1995, while inflation is expected
to hold steady or even pick up a bit.
This Economic Commentary is a summary of the group's November 3
meeting, held at the Federal Reserve
Bank of Cleveland.

moderate to a 2.9 percent pace this quarter, although the range of expectations is
relatively wide—from highs of 3.6 percent to lows of just under 2 percent. As
we move into 1995, the economy's
growth trajectory is expected to return to
a level similar to its postwar average,
about 2.5 percent.
The probability distributions of the
growth projections for 1995 and 1996
were fairly uniform, and the panel sees
little prospect of a recession during the
next two years. Chances that the economy will average less than a 2 percent
growth rate were set at no more than one
in five for 1995 and at only about one in
three for 1996.
Many analysts believe that inflationary
pressures become prominent only after
an economy's resources have been
stretched to capacity. This occurs if a
nation's actual growth rate exceeds its
potential growth rate for a sustained

period or if the rate of unemployment
falls below its "natural" level. However,
there was no obvious consensus among
the participants on where the U.S. economy's capacity stands (table 1). Most
think that the potential growth rate is
near 2.5 percent per year — similar to
the group's 1995 GDP forecast. But a
significant contingent believes that the
potential growth rate may be substantially higher: More than 20 percent set it
at 3 percent per year or more. Similarly,
about one in three panelists thinks that
full employment will not be reached
until the jobless rate falls into the 5.4 to
5.6 percent range, about lA percentage
point below its October level.

Percent change, seasonally adjusted annual rate

Percent change, seasonally adjusted annual rate

4.0 -

Understanding, let alone predicting,
cyclical movements in the economy has
frustrated economists for centuries. Surprisingly, the variations in business activity that tend to get the most attention —
business cycles — are generally much
smaller than the variations that occur
over the course of a typical year, or the
"seasonal cycle." Indeed, it has long been
recognized that seasonal fluctuations are
the dominant source of overall changes
in business activity: Harvests are abundant in the fall, but obviously scarce during the winter. Industrial production
drops off during the summer as workers
take vacations, and spending is strong
late in the year as shoppers prepare for
the holidays. But seasonal fluctuations
are presumed to be easily predicted and,
moreover, to fall beyond the scope of
economic policy. Thus, they are seen as
being of little practical relevance.
Failure to predict and control the business cycle using conventional economic
theory has led many economists to reexamine the seasonal cycle in hopes of
shedding new light on the origin of busi-


3.0 -



Few in the group expect any measurable
improvement in inflation over the next
year or two, however, and there is a general belief that it may actually pick up
slightly in the latter half of 1995 (figure
2). The most optimistic projections see
the Consumer Price Index (CPI) rising at
a 3 percent pace over the next five quarters, not much different from its trend
over the past five quarters. The pessimists in the group see inflation moving
just above 4 percent next year.












a. Preliminary data.
NOTE: High and low are the average of the three highest and lowest forecasts, respectively.
SOURCES: Fourth District Economists' Roundtable, Federal Reserve Bank of Cleveland, November 3, 1994;
and U.S. Department of Commerce, Bureau of Economic Analysis.

ness cycles. In a very practical way, our
understanding of the business cycle
depends crucially on our understanding
of the seasonal cycle. Because most
economists employ data that have been
"seasonally adjusted," or purged of their
presumed seasonal movements, any mismeasurement of the latter guarantees a
misinterpretation of the former. More
generally, many of the same issues we
struggle with in our search to understand
and forecast the business cycle are also
true at a seasonal frequency. So what is
the source and propagation of these fluctuations? Jeffrey A. Miron of Boston
University and the National Bureau of
Economic Research (NBER) discussed
his work on seasonal cycles and their
shared traits with the business cycle.

• Seasonal Cycles
and Business Cycles
Jeffrey A. Miron,
Boston University and the NBER
Macroeconomists typically study business cycles, the short-term, irregular ups
and downs in economic activity. These
fluctuations are obviously of great interest, but they are not the only kind of
short-term fluctuations. Another impor-

tant source of such variations is seasonal cycles, the regular ups and downs
that occur on a yearly basis.
A first fact to note about seasonal cycles
is that they are large in comparison to
business cycles. In the United States,
real GDP declines about 8 percent from
the fourth quarter to the first quarter on
average, or at a 32 percent annual rate.
Thus, accounting for seasonal fluctuations has potentially substantial implications for the study of business cycles.
The second striking fact about seasonal
cycles is that they display many of the
same empirical regularities as business
cycles. Over the seasonal cycle, real output and nominal money are highly correlated, production and sales move together
closely, labor input appears insufficiently
responsive to movements in output, and
fluctuations in output across disparate
sectors of the economy are highly correlated. These are the same stylizedfacts
that characterize business cycles.
In addition, the amounts of seasonal and
cyclical variation are correlated crosssectionally. Specifically, countries and '

What is the current growth rate of
potential GDP?

What is the current natural rate of
Percent of

Percent of






What federal funds rate do you prefer at
the present time? (October rate = 4.76%)

What federal funds rate do you judge to
be consistent with price stability?

Percent of



Percent of



NOTE: Percentages may not sum to 100 because of rounding.
SOURCE: Fourth District Economists' Roundtable, Federal Reserve Bank of Cleveland, November 3,1994.

industries that display large amounts of
seasonal variation also display large
amounts of cyclical variation. The most
natural explanation for this robust empirical finding is that the economic mechanisms that propagate seasonal cycles are
similar to those that propagate business
cycles. Thus, this finding suggests that
one can learn about the nature of business cycles by studying seasonal cycles.
Study of the seasonal fluctuations in specific sectors of the economy has provided
a number of interesting conclusions
about the nature of aggregate fluctuations generally. For example, examination of the production behavior of the
manufacturing sector suggests that cost
shocks are an unimportant source of
aggregate fluctuations. Continued attempts to integrate the study of seasonal
cycles and business cycles appear to be a
highly promising avenue for expanding
our knowledge of both kinds of cycles.
The similarities between seasonal cycles
and business cycles may be more than
just an intellectual curiosity and may provide general insight into the origin of
cycles. Several recent articles have suggested that the seasonal cycle and the

business cycle are intertwined, such that
our estimation of one cannot be made
independent of the other. That is, the seasonal cycle may be contingent on the
current state of the business cycle. One
such article was co-authored by Stephen
G. Cecchetti of Ohio State University
and the NBER, who talked with the
Roundtable about his work.

• Interactions between Seasonal
Cycles and Business Cycles
Stephen G. Cecchetti,
Ohio State University and the NBER
Real-time analysis of the detailed components of industrial production suggests
that interactions between seasonal and
cyclical shifts are quite common. One
example of such an interaction comes
from the recent experience of firms in the
paper and pulp industry. Near the end of
the expansion of the 1980s, nonseasonally adjusted data showed that the industry was operating continuously at very
high rates of capacity utilization. But
because production hadfluctuated seasonally in the past, reported seasonally
adjusted numbers showed variation in
output. In particular, declines were noted
in seasonally adjusted output during the
typically high production months.

Using disaggregated data on production, it is straightforward to show that
seasonality is not the same at different
stages of the business cycle. For example, seasonality in output in the oil
industry, as measured by the variance in
the seasonals, declines by nearly half
from a typical recession to a typical
boom. By contrast, going from a recession to a boom raises the seasonality of
transportation equipment production by
a factor of three and one-half!
What can we learn from this, and what
problems does it pose? In a recent paper,
my co-authors and I discussed how we
can use this empirical evidence, together
with information on inventory fluctuations, to help determine the structure of
firms' production costs.' Our findings
allow us to comment on a recent academic debate over the causes of business
cycle fluctuations. If firms face increasing returns to scale, meaning that the
marginal cost of producing an additional unit of output declines with the
quantity produced, then it may be possible to explain business cycles by appealing to the idea that there are naturally
high and low periods of activity stemming from the efficient use of resources.
Although our evidence is consistent with
this possibility in several isolated industries, it is not widely true, so we discount
the possibility that the cycles are due to
the optimal temporal bunching of economic activity.
Beyond the academic interest in these
findings, they also have some practical
importance. To the extent that business
cycles and seasonal cycles are intertwined, standard seasonal adjustment
techniques will not work. In fact, the use
of government-supplied seasonally adjusted data may give an inaccurate
impression of the nature of cyclical fluctuations. To see why, return to the paper
and pulp industry example and note that
if a business cycle downturn were to occur in the month following a naturally
high season, then the turning point would
be mistimed: One would think that the
downturn began before it actually did.
The lesson is to use seasonally unadjusted
data whenever possible, keeping in mind
the possibility that seasonally adjusted
data may be easy to misinterpret.


Advice to Policymakers

As is generally the case, the Roundtable
also turned its attention to the conduct of
monetary policy. Since the group's previous meeting in May, short-term interest
rates were nudged up by half a percentage point in a continuing effort that
began last February to stem the economy's growing inflationary potential.
The panelists were generally of the view
that the federal funds rate, the primary
policy instrument of the Federal Reserve,
was set too low (table 2). Half of the
group preferred to see the funds rate in
the 5 to 5Vi percent range (about 50 basis
points higher than its level on November
3), while another third preferred to see it
moved above 5Vi percent, presumably in
response to the higher inflation rates the
group is projecting.
In fact, 44 percent of the participants
agreed that a funds rate of 6 percent or
more would eventually be required to
achieve the Fed's stated objective of

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price stability, compared to less than 20
percent who believe that the October
rate is sufficient to achieve that goal.
This appears to be what the group
expects from policy: Over the next four
quarters, short-term interest rates are
seen moving to 6 percent. We can infer
from the panelists' forecasts of real output, coupled with their expectations for
monetary policy, that they believe further restraint would dampen the expansion without necessarily inducing a
recession. In other words, higher interest rates would successfully prevent an
inflation surge while keeping business
activity on track.
On November 15, the Federal Open
Market Committee, the chief policymaking arm of the Federal Reserve,
took a decisive step in that direction,
pushing the fed funds rate up % of a
percentage point, to 5Vi percent. But if
the nation's central bankers hope to
reduce inflation from its recent 3 percent trend, then slightly higher short-

term rates may be necessary, at least
according to a large proportion of the
Roundtable participants.
Whether or not the Federal Reserve follows that advice undoubtedly depends
on how the economic data unfold in the
months ahead. The Roundtable will
reconvene on March 31, 1995.

• Footnote
1. See Anil K. Kashyap, David W. Wilcox,
and Stephen G. Cecchetti, "Do Firms
Smooth the Seasonal in Production in a
Boom? Theory and Evidence," unpublished
manuscript, October 1994.

Michael F. Bryan is an economic advisor and
John B. Martin is a senior research assistant
at the Federal Reserve Bank of Cleveland.
The views stated herein are those of the
authors and not necessarily those of the Federal Reserve Bank of Cleveland or of the
Board of Governors of the Federal Reserve

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