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Predict Now, Revise Tomorrow

Irwin M. Stelzer

Here with some thoughts about the outlook for this year. Thoughts, not forecasts, for which I have neither the skill nor the courage. I offer these thoughts in deference to the understandable demand for look-aheads. Human beings are always hunting for certainty, attempting to reduce randomness, surrendering to what Harvard’s Walter Friedman in his new book (Fortune Tellers: The Story of America’s First Economic Forecasters) calls “the near universal compulsion to avoid ambiguity and doubt.” But there is more to the demand for forecasts than this desire for certainty. Businessmen and policymakers want to use forecasts to change the future, to adapt products to predictions of changes in consumer taste, to structure finances so as to take advantage of predicted changes in interest rates and thereby change earnings in the coming year, to obtain “the ability to alter the very thing that one predicts,” to borrow from Friedman. In short, it is often the goal of the purchaser of a forecast to act so as to prove his seer wrong, and then hire him the following year to repeat the process.

Recent data suggest that 2014 will be a better year than 2013, at least so far as the economy is concerned. Yet more than 60 percent of Americans think the country is on the wrong track, that things will get worse in this new year. One possible explanation for this divergence is that the wisdom of crowds is not all it is cracked up to be. Another is that the cheery data are gossamer, to be blown away by the gusts emanating from the Federal Reserve Board’s announced tightening of monetary policy, its beaching of QE3. A third is that the data correctly portend better times, but the majority of Americans who argue that we are on the wrong track do not expect to benefit, at least not sufficiently to feel as if they are benefitting. Increased economic growth cannot convince the 1.3 million recipients of emergency unemployment benefits who will be losing about $300 per week unless congress acts, or the millions of middle class families suddenly afflicted with the higher health insurance premiums imposed by Obamacare, that the country is on the right track. Even beneficiaries of an improvement in their own economic circumstances, but among the majority of Americans who say their president is neither honest nor trustworthy, can reasonably argue that the nation is on the wrong track, their own good fortune notwithstanding.

Still, and despite these dissatisfactions, consumer confidence is rising, with expectations for the future and for job prospects leading the indicator up from levels reached during the October government shutdown. These confidence polls are not an infallible guide to consumer behavior, but better an upward movement than a downward plunge, especially when the improvement in confidence seems firmly rooted in economic reality.

That reality is this. The housing market, which last year contributed importantly to such growth as the economy managed, shows little sign of flagging. With average house prices still about 16 percent below the pre-bust high (the average conceals a wide range for different cities), we do not seem to be in bubble territory. Nor are we likely to enter that danger area now that mortgage rates have risen in response to the Fed’s decision to “taper”-reduce its $85 billion monthly bond-buying by some $10 billion, reversible if the economy falters. With the demand and supply of houses more nearly balanced, home builders are stepping up construction. Prices will continue to rise, although only half as rapidly as they did last year if experts prove right. It is not inconceivable that we will have a Goldilocks housing market this year. Not too hot (bidding wars will be fewer), nor too cold (so will foreclosures and sales of distressed properties).

Even more important is the outlook for the jobs market. The Fed now expects the unemployment rate to decline from 7.0 percent to somewhere between 6.3 percent and 6.6 percent, reflecting its “confidence that the job-market gains will continue.” The consensus among economists is that the economy, its manufacturing sector now operating at pre-recession levels, will add close to 200,000 jobs per month, bringing total employment to pre-recession levels before July. Still, when that milestone is reached, six million fewer Americans will be at work than would have been employed had the downturn not occurred. Whether continued growth will begin to lure workers who have dropped out of the labor force back into the market is as yet unknown. Liberals say recent increases in the minimum wage will make work more attractive, conservatives that those raises will destroy jobs. Liberals say that unless the emergency unemployment benefits are restored aggregate demand will shrink, conservatives that restoration of benefits would reduce the force of this new prod to get off the couch and participate in the labor force. Good economists can found who support each of these arguments.

Harvard’s Larry Summers, Obama’s preference to fill Bernanke’s seat but shot down by leftish senate Democrats, worries that even with some improvement we will not achieve “escape velocity” and return to full employment any time soon. Instead, he muses, we may have entered an era of “secular stagnation” in which the economy persistently underperforms and unemployment remains high. Unless, of course, a dose of Keynesian medicine is administered soon, spiked perhaps with a bit of income redistribution so that a larger portion of national income goes to those most likely to spend it.

Even if Summers is wrong-and he very often is right-forecasters, the majority of whom say 2014 will be a rather good year, have reason to be nervous. On a theoretical level, they have to worry that the models that failed to predict the recent recession, undoubtedly improved by some tinkering, are still not up to the job of predicting the course of the economy with reasonable accuracy. Emanuel Derman, a former Goldman Sachs modeler and managing director turned Columbia academic, writes in his Models Behaving Badly, “Models necessarily simplify things … squeeze the blooming buzzing confusion into a miniature Joseph Cornell box, and then, if it more or less fits, assume that the box is the world itself.”

On a more practical level, forecasters have to face the fact that the real world abounds in what former Defense Secretary Donald Rumsfeld called “known unknowns.” We cannot know how the wave of regulations the administration has in store for American industries will affect growth and hiring. These rules range from those aimed at closing the coal mining industry to rules “incorporating personal fall protection systems into the existing general industry rule for Walking and Working surfaces.” We cannot know if the reforms imposed on the financial sector will so curtail banks’ ability to take on risk as to reverse recent increases in bank lending to small businesses. Then, there is Obamacare, with its bevy of new taxes on “the rich” and its higher costs for many businesses, its effects unknowable at this early stage in its troubled introduction. All likely to affect growth rates, but in unknowable amounts.

Throw in the turbulent world out there, beyond our shores. A soon-to-be nuclear-armed Iran might further destabilize the Middle East, pushing up oil prices and putting paid to the notion that we are now independent of the volatility of world oil markets. We might see the great fall of China as its leaders attempt to rein in excessive credit and reduce excess manufacturing capacity by closing down state-owned enterprises. Capital flight might drive emerging nations into recession. Some eurozone banks might finally collapse under the weight of their bad loans. There’s more, but you get the idea. The world is very much with us.

These are only some of Rumsfeld’s “known unknowns.” Lurking in the wings to make life for forecasters a series of mea culpas and revisions are the “unknown unknowns.”

Have a wonderful, exciting New Year.

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