The ABCs of forecasting the economy

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Where is the U.S. economy headed? Is the current downturn going to follow a V-shape — or maybe a U? Economists have come up with an alphabet soup of forecasts lately. We'll take a look at theirs and offer up one of our own.

When do you see the economy getting better?
— Betty, address withheld

We used to rely on our Answer Desk crystal ball for help with economic questions like this one. But no matter how much data we fed it, we couldn’t get a straight answer. So we traded it in for a flat-screen TV. Now we can watch economic forecasters come up with creative new ways to dodge the question.

Lately, they’ve been reverting to what we’ll call the ABCs of economic forecasting, assigning letters of the alphabet to their predictions.

For awhile, a lot of them were calling for a “V-shaped” recovery. This scenario calls for a sharp drop down (the left side of the V) followed by a quick recovery. The hope was that the faster the housing and credit markets hit bottom, the sooner everyone could start rebuilding.

But following the collapse of the credit markets last summer and the resulting gyrations in the financial markets, things seemed to be just muddling along. Since we didn’t get a sharp drop, the thinking went, a rapid recovery was unlikely. That got us to the “U-shaped” recovery — a more gradual slide down followed by a gradual climb back up. (A lot of the V-shaped crowd started using this one.)

More recently, we started hearing about a “W-shaped” recovery. According to this analysis, the economy turned down in late 2007 and early 2008 and we’re just now beginning to come back up to the mid-W peak, thanks to the Federal Reserve’s aggressive interest rate cuts and the flood of tax rebates now hitting the economy. Alas, this letter-based forecast suggests those measures won’t have a lasting impact. Once they wear off, the thinking goes, we're going slide down the right side of the mid-W peak before things get better again, perhaps next year.

Lately, we’ve heard another letter invoked: the dreaded “L-shaped” economy. This forecast says the economy slides along at pretty much zero growth — and stays there until mid-2009 or beyond.

If so, we’re hoping that “L” runs into a “J” sooner rather than later and gets us back on track for higher growth and lower inflation. Still, it’s hard to see how that happens as long as employment and house prices are falling and energy prices and home foreclosures are rising. The threat of ever-higher inflation could force the Fed’s hand and drive interest rates back up again — just when the economy needs the tailwind of a continued policy of cheap money.

A lot depends on how soon our government gets serious about tackling some serious economic issues. Start with a sane energy policy, maybe one that encouraged conservation and development of new sources of power instead of just helping oil companies pump more crude. (To start, you could cut the huge corn ethanol subsidies that are forcing up food prices and feeding inflation. There are other, better ways to brew the stuff.)

It also wouldn’t hurt to get serious about cleaning up the mortgage mess. With millions of homeowners stuck in ruinous mortgages facing sky-high payment resets, why not let them convert those exploding loans to fixed, market-rate mortgages they can afford?

So far, the lending industry’s voluntary “workouts” just aren’t cutting it. And if someone doesn’t defuse the alternative minimum tax bomb this year, another 20 million or so American families are going to have to figure out how to come up with tens of billions of dollars in taxes they didn’t owe last year.

Unfortunately, with the election now getting into full swing, Congress and the White House seem to be gripped with a quadrennial case of kick-the-can-down-the-road politics. Unless and until government can get its act together, The Answer Desk is calling for an “O” shaped recovery — with Washington going round and round in circles and the economy going nowhere.

Do you think all the economic info coming from Washington is true?
— Clifton D. San Angelo, Texas

As the old saying goes, “There are lies, damn lies — and statistics.”

“Truth” is a tough objective when it comes to measuring the economy, for several reasons.

First, it takes a long time to collect enough data to create a meaningful picture of what’s going on. That’s because “the economy” is really a collection of every job won or lost, every sale or purchase by every consumer, business, government agency, non-profit group, school, hospital, church, etc., the proceeds of every investment bought or sold, the manufacture of every new house, car, bedroom set, big screen TV and on and on.

That’s why pretty much every meaningful piece of economic data is a guess. In some cases, these are very good guesses — based on sound survey samples and solid statistical techniques. In other cases, the data are almost always “noisy.” If you put them all together, they sometimes — but not always — point in the same direction. That’s why economists come up with such different conclusions when they read the same set of numbers.

The other big reason economic “truth” is elusive is that much of the analysis is based a very incomplete understanding of human behavior and psychology — which can shift as rapidly as the data is collected. As oil prices have risen for the past several years, for example, it was widely assumed that energy consumers would change their behavior accordingly. Few predicted that consumers would tough it out this long before trading in their SUVs for higher-mileage cars. The latest round of layoffs in Detroit are a response to that shift; some suggest that automakers were “caught by surprise” as the market for light trucks collapsed.

Even at this stage, it’s not entirely clear where energy prices are headed: that uncertainty spills over into decisions about car purchases, how far from work we live, how far to tighten our budgets, whether to take a summer vacation, etc. So the only real “truth” is: No one knows.

Some readers insist that the “inaccuracy” of government economic data is deliberate, that the numbers are being manipulated to adhere to a political agenda or to portray the incumbent administration in a better light. There are certainly shortcomings in the way the data are collected and analyzed: Private economists sometimes take issue with the way their counterparts in government assemble the official numbers. (Various methods of “seasonal adjustments,” for example, are one of the most common sources of debate.)

But the idea that some political appointee is reviewing and editing these reports before they’re published is, in our opinion, not very credible. For one thing, these data are very closely scrutinized and compared with private, independent surveys and data sources. If you tried to cook the books, your conspiracy would have to include an awful lot of people both inside and outside the government.

More to the point, if someone is spinning the data, they should be fired. The latest numbers are hardly painting a picture of the kind of economy you’d like to see in an election year.