Predictions Hard, Especially About the Future

The CBO's latest projections see an economic slowdown that doesn't become a recession. The letter accompanying the projections also nicely encapsulates why you won't see me doing any macroeconomic forecasting (emphasis added):

CBO’s previous forecast, which was embodied in budget projections released in January, was finalized in early December 2007. However, data released since then––especially regarding the labor market––indicate that economic conditions are weaker than previously projected, and conditions in some segments of financial markets remain worrisome. Other indicators––such as production indices and information on retail sales and sales of new homes––also suggest a slowing in economic activity.

At the same time, changes in monetary policy have been more substantial than CBO assumed in December, and fiscal policy stimulus has been enacted. The Federal Reserve reduced the target for the federal funds rate by 125 basis points in January, and financial markets anticipate further easing in the near future. In addition, the Economic Stimulus Act of 2008 will provide about $150 billion in tax rebates and business tax deductions in fiscal year 2008. CBO anticipates that the recent monetary and fiscal policy actions will provide significant support to the economy in 2008.

Basically, one of the biggest determinants of whether or not there's going to be a recession is whether or not the Fed thinks there's going to be a recession. If they think it's likely, they'll act aggressively to avoid one and there likely won't be one. If they don't think there's going to be one, then there just might be a recession. At that point, though, in terms of accurate forecasting we're talking about mind-reading rather than economics.

Comments

Well, that's not quite right. After all, you could write a "reaction function" for the Fed, which would probably be weakly predictive. There are macroeconomists all over the place who feed data into their general equilibrium models, which include monetary policy components. Sure there's a lot of give in the numbers, but is any other field really markedly better?

Posted by Marshall | February 18, 2008 2:38 PM

Of course, both the fiscal and monetary reactions will, in this case, invariably lead to further weakening of the dollar, which is already in freefall.

I just don't see any graceful landing to this.

Posted by Brautigan | February 18, 2008 2:56 PM

no, basically, the media has decided that if they say there's no recession, there won't actually be a recession.

Lets get serious, those rate cuts have done nothing and this stimulus package was worthless. Any report claiming otherwise is probably not very accurate.

It is Ironic that, in a post title 'Predictions are hard, especially about the future', that Matt decides that someone shifting their predictions for the future constitutes an actual shift in the realities on the ground. It doesn't. I only changes what this report is going to predict about the realities on the ground.

Posted by Soullite | February 18, 2008 3:12 PM

Of course, if as Krugman says, the Fed's rate cuts are the equivalent of pushing on a string, then the Fed's ability to forestall a recession by predicting it isn't really there.

Posted by low-tech cyclist | February 18, 2008 3:32 PM

I also get the feeling that the Fed, and the government, want to avoid telling us their true assessment of the risk of recession for fear of making things worse. And since acting to forestall a recession would tip their hands, they're likely to wait too long and do too little.

Posted by Barry | February 18, 2008 4:11 PM

Basically, one of the biggest determinants of whether or not there's going to be a recession is whether or not the Fed thinks there's going to be a recession.

I don't think this is true. The Fed's monetary tools for avoiding economic downturns are relatively ineffective at preventing recessions. Note that recent rate cuts have done nothing to affect longer-term interest rates - those rates that are relevant for making business investment decisions.

Posted by Nordy | February 18, 2008 4:13 PM

All of this is based on the somewhat arbitrary definition of a recession as 2 consecutive quarters of negative economic growth. Even if we manage to avoid accomplishing that, it doesn't mean that a bunch of people haven't lost their jobs and homes or that a bunch of market value hasn't been erased.

Posted by mike | February 18, 2008 4:23 PM

Okay, can't have recession if the fed opposes. If so, why do we ever have 'em? Is the limit to fiscal or economic shenanigans that the fed can't cure? Can the chickens of deficit spending, forever borrowing stupendously against the future, go on forever? Why can't we have a zero interest rate? Hell, why not -5%? Forever! What, there are no costs no pitfalls of throwing borrowed money at the problems forever?

Posted by Footloose | February 18, 2008 4:23 PM

Basically, one of the biggest determinants of whether or not there's going to be a recession is whether or not the Fed thinks there's going to be a recession. If they think it's likely, they'll act aggressively to avoid one and there likely won't be one.

The perfect summary of the conventional wisdom, and totally wrong. If Matt didn't take Econ 102 then maybe he can be forgiven, a little.

Here is the most important thing you have to know. Banks are no longer are the largest supplier of systematic credit. Those days are long gone. Most mortgages and all manner of CDO's, collaoralized debt obligations, are created outside the banking system, on Wall Street. Huge swaths of the non bank credit market are freezing up. Old paper is not trading and new credit from these sources is not forthcoming.

Banks could not possibly replace what has been lost because as we are seeing so much of this credit was absolute crap. Lent at too low rates to people who shouldn't have gotten it in any case. Besides which banks are in serious trouble and even traditional bank borrowers are not finding getting loans easily. Certainly not at favorable rates, despite the Feds lowering of the target

The business cycle is the credit cycle. Period. .We are in the early innings of a credit contraction larger than any since the depression. We have been on a credit binge since 1982. The answer to the Malaise was credit. As time went on the credit expansion became a bubble. The Credit Bubble was the father and mother of all the other bubbles. In 1980 $1 in credit produced $1 in GDP growth. By 06 it took $8 in credit to produce $1 in GDP growth. Even worse that growth was mostly devoted to consumption.

The Fed is powerless to reflate the credit bubble.

Posted by rapier | February 18, 2008 5:51 PM

http://cdn2.libsyn.com/wallstreetexaminer/rf021508pv.mp3

Posted by rapier | February 18, 2008 5:57 PM

Why were there ever recessions?
Did the Fed since it's inception in 1913 make mistakes and not head them off?
Does a recession serve any purpose?

Ups and downs in economic output used to be considered natural to market systems. No more evidently. Very smart people think that markets can be managed sucessfully forever and I suppose they think they should be managed so as to preclude any period of negative growth ever.

The conventional wisdom has become neo Keynesian on acid. (I don't use the term Keynsian in any pejorative sense) I don't care if your a Marxist or Austrian School ideolog, or somewhere in between. The idea that the Fed ultimately controls the economy is profoundly silly and.no economic theory even pretends that it can. (Self interested players might believe it or pretend to but that's another matter) Suggesting that it does takes the analysis of economics to the heights that Jonah Goldberg takes the analysis of political philosophy.

Posted by rapier | February 18, 2008 9:12 PM

Matt: "If they think it's likely, they'll act aggressively to avoid one and there likely won't be one."

You're clueless, Matt.

Utterly clueless.

Posted by Richard Steven Hack | February 19, 2008 12:02 AM