May 26, 2009

Prognostications On The Economy (update 6-26)

Most people reading this blog will have read some prognostications on the economic future of the next 1-2 years, talking of what will happen in 2010.

These longer-term forecasts are fantasies.

While the mainstream prediction of some economic stabilization this year followed by modest GDP growth and continuing job losses makes sense, even this middle-of-the-road 6-month forecast is similar in reliability to a 2-week weather forecast during the spring or fall.

It might happen that way.

Exactly like a weather forecast, and for precisely the same scientific reasons, economic forecasts are relatively useful for a short-term outlook, and less and less meaningful for a longer term outlook.

I'm quite deliberate in this choice of language. Just as randomness changes the weather progressively more over time versus any specific scenario, the same effect applies to large economies. But while long-term weather usually follows seasonal averages with moderate deviation in most years, the long-term economy has more randomness and higher deviations.

Right now the biggest unknown is future evolution of expectations and the consequent choices individuals will make in response.

This is not at all predictable.

We can predict some aspects of the economy, such as national housing price changes, due to the highly consistent effects of supply versus demand -- when the supply of homes for sale is significantly more than 6-7 months worth, prices fall. The effect of significant supply along with significant expected shadow inventory (those with houses not currently on the market who would like to sell, and are waiting for the recession to ease) practically guarantee further price falls in many areas, and on national averages.

But some critical economic factors in the broad economy are fully unpredictable. That is, the degree of unforeseeable change is very high.

The economy is, after all, the joint decision of all of us together.

We can en masse pull back on our spending out of fear of job losses, creating a self-fulfilling outcome of continuing high job losses.

Or we can en masse gain confidence in the economy, and thus feel more secure in our jobs, and spend a little more, creating a self-fulfilling outcome of reduced job losses, and even an improving economy.

The most crucial part of the stimulus program -- the American Recovery and Reinvestment Act of 2009 -- is how it affects general confidence in the economy.

This is because general confidence will determine changes in consumer spending of greater scope than the amount of actual stimulus spending.

A popular forecast like "weak growth of 0.5% in the 2nd half of the year" is only a guess.

Fortunately, one of the greater forces in the economy has changed direction.

We can all breathe a little easier to see this news today:

Consumer confidence extended its rebound in May, soaring to the highest level since last September as more shoppers are feeling the worst of the recession is behind them....

This is no small thing.

Sufficient confidence could give the actual stimulus dollars much more traction, leading to a very different economic outcome over time. How different? Well, long-term interest rates for instance depend on investor confidence in America, which in turn depends on the American economy, which itself depends on small changes adding up over time...

Update 6-26

(Reuters) - U.S. consumer confidence rose in June to the highest since
February 2008, as expectations grew that the worst economic recession since the
Great Depression may be ending, a survey showed on Friday.

Today we also learned the savings rate has shot up to 6.9% for May from 5.6% in April. New unemployment claims are still very high, ticking back up a bit.

But of all the indicators, most key are confidence and actual consumer spending (up 0.3% month over month).

These two suggest some possibility of real stabilization, instead of a downward spiral. What's unknown is how many layoffs have been delayed on hope of a bigger rebound in spending. The next 2 months will decide if this stabilization is firm, or only a pause. But I'm cautiously hopeful that this stabilization can hold, so that the economy may be at the bottom here, instead of a worse scenario. It's not certain, but it's a good sign.

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