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What Should We Think Keynes Meant?

Strength of the Recovery: Robert Shiller Is Alarmed

Bradley Davis reports:

Shiller Sees ‘Substantial’ Probability of Recession: “Forecasting models would say no” on the question of whether the U.S. will face a double-dip, Shiller said. “But I’m seeing signs that encourage me to worry about that.” Shiller, who is one of the two men behind the S&P Case-Shiller home-price index, said home prices could still decline despite being lower than where they were more than five years ago. The summer season could see a pickup in prices, he said, but “I still worry about the general downtrend.”

“There might be a turnaround if psychology changes,” he said. But “I fear that it may just continue down.

“It just doesn’t look good,” he said in an interview with The Wall Street Journal...

I am not sure why he is alarmed in spite of forecasting models' non-pessimism. So let me tell you why I am alarmed.

One way to think of large-scale forecasting models is that they are essentially vector autoregressions surrounded by a shell of behavioral equations and accounting relationships. The purpose of the equations and relationships is to trigger alarm bells in your mind when you look at the vector autoregression forecast--and then decide whether or not you want to incorporate an add factor. This methodology does, I think, work pretty well for forecasting: it works much better than a poke in the eye with a sharp stick, for example.

But the underlying VAR correlations still largely come from an age of inflation-fighting recessions and rapid bounce-back. Thus that is an input to what the markets are forecasting. And is that input still valid for today?

That is why I am alarmed.