Unlike inaccurate weather forecasts where we can make alternate plans with little or no consequences in the larger scheme of life, wrong economic forecastsing can have serious consequences. Even when making decisions about your financial future involves educated guesses, guessing may be a better alternative than making no forecast at all.

Unfortunately, economic forecasting is far from an exact science. Professional economists may strongly disagree on the direction of the economy at any given point in time, based on their differing interpretations of conflicting economic indicators. This discussion will focus on two key points that can help you get a better feeling for where our economy currently stands, and in what direction it may be headed in the near future.

How Much Longer. . .?

Economic forecasters are always searching for storm clouds that might signal an economic downturn. Since consumer spending accounts for nearly 75% of the economy, many observers look to "pocketbook" issues in search of primary clues about which way the economy may be heading. While consumers don't usually cut back first and cause a recession, buying more on credit translates into greater monthly payments, and, at some point, consumers can do only what their incomes will allow. As personal debt rises per capita keeping an eye on consumer debt levels is important because of the sheer weight of total consumer spending in our economy. At the same time, current federal decisions that set the foundation for our overall economic climate is something that also needs to be watched as the actions of the federal government can affect consumers spending habits.

The Role of the Federal Reserve Bank (the Fed)

Every observer of business news knows that "Fed watching" is a serious activity in the financial and business communities. You may be asking yourself, "What makes the Fed so important?" While consumers can affect the economy by acting according to their own perceptions and pocketbook pressures, federal policy decisions, such as fiscal and monetary measures, also moves the economy. Fiscal policy enacted by Congress in the form of tax and/or spending legislation, is the by-product of the political process and the prevailing political climate. In contrast, monetary policy is the purview of the Fed who evaluates all of the forces acting on the economy (individual, market, and governmental) and takes action to keep the economy on an even keel.

The Fed can manipulate the money supply in hopes of obtaining a desired effect over time. However, the most effective short-range policy decision with which to manipulate the economy are short-term interest rates. Consequently, the Fed can realistically have only one target - inflation. If the Fed perceives that the prevailing forces will increase inflation, it will attempt to slow the economy by raising short-term interest rates (the assumption is that increases in the cost of borrowing money are likely to dampen both personal and business spending behavior). Conversely, if the Fed perceives that the economy has slowed too much, it will attempt to stimulate growth by lowering short-term interest rates (i.e., lowering the cost of borrowing). If it doesn't tighten the reins soon enough (by raising interest rates), it runs the risk of inflation getting out of control. If it fails to loosen soon enough (by lowering interest rates), it can plunge the economy into recession. Indeed, one might argue that the primary goal of the Fed is to keep inflation low enough it is not a factor in business decisions.

Up, Down, or Sideways?

By watching your own spending outlook and debt burden and that of your friends, relatives, and business associates, you may gain some insight into the short-term future of the economy. When combined with judicious Fed watching (e.g., several interest rate moves in the same direction may be an indication that the Fed is on a mission) and done in consultation with your qualified financial service professional, you may have a good basis for making decisions with regard to your own financial future.