Hope Is Not a Model Either: Macro Forecasting
Remember the state of play: Macro Advisers (and many others) are forecasting roughly 3.4%/year real GDP growth over the next six quarters, with a large 1.2 oercentage-point decline in the unemployment rate--Okun's Law would suggest 0.6 even with that GDP forecast--accompanying it.
I suspect a bunch of the unemployment snapback is based on an assumption in the model that if you deviate from Okun's Law you are likely to snapback. That deviation that we thought existed is now gone as a result of the revised GDP path. I suspect that the next forecast iteration will show an end-of-2012 unemployment rate closer to 8.5% than to 8.0% even if the GDP path remains the same.
But let's concentrate on the GDP path. Karl Smith writes:
Structure of a Recovery « Modeled Behavior: I haven’t seen the internals of the Macro Advisors model but these numbers don’t sound off to me as a baseline. How would they come about?
- Rapid increase in multi-family housing built to rent….
- An end to fiscal contraction. The contraction in State and Local spending has been an intense blow to both employment and GDP. However, this should be coming to an end…. What we need is for State and Local to simply stop contracting.
- Net Exports. This is a hard call with all that is going on in Europe but both inflation and growth in the developing world should be slowing US import growth and increasing US export growth.
- Believe it or not, consumer spending. Consumer spending has not been a superstar but until the last quarter it was decent enough. Gas prices are the biggest variable here, but again I do not see the fundamentals supporting oil over $100 a barrel….
- Continued heavy investment in Equipment and Software by businesses. The current strength in E&P is hard to explain and its easy to see it going away. However, if you just assume that something that we don’t fully understand is boosting investment and look at it from a business cycle perspective then a strengthening economy should lead to even more rapid E&P accumulation.
Now, of course predictions are hard – especially about the future…. However, gloom is not a model. You have to base your best guess on your best understanding of the underlying economy. To me that points to growth, even if we have seen a string of disappointments over the last nine months.
It could happen. The future is uncertain. But I cannot help thinking that it would be wise to bet against Karl Smith's future's happening:
If people were going to try to move out of their sisters' basements into multi-family units, I think that they would have done so already--and that we would already have see rents rising. I do expect a multi-family housing construction boom, but it will follow rather than precede a rise in rents that has not happened yet.
Fiscal contraction is ongoing, and accelerating.
The Asian Import Fairy could show up, but I see no reason to think that trends will be markedly different from what they have been in the past year and a half.
Lots of people now know people who lost their job and have not yet managed to find another appropriate one even though it has been years. That is likely to impact consumer willingness to spend in a way that is hard to incorporate into the baseline model.
Businesses have been taking advantage of relatively healthy cash flows and low interest rates to invest in equipment and software at a very gratifying pace--a pace that I would say ought to be associated with above-trend capacity growth. But if demand is growing at less than trend and the capacity utilization rate is low, why should above-trend capacity growth continue?
We have had a non-declining 9% plus unemployment very low interest rate economy for two years now. And the employment-to-population ratio has not moved. Something about the future must be different from the recent past in order to get it to move upward. Starting in 1994 it was the dot-com boom that pulled us out of that jobless recovery. Starting in 2004 it was the housing boom that pulled us out of that jobless recovery. What is going to pull us out of this jobless recovery? I don't see it yet.
In my view the chance that the unemployment rate will be 9% or higher at the end of 2012 has just crossed 50%, heading upward.