Dueling forecasts

When smart people debate, something interesting is bound to come of it, so I have been reading an interchange over the past couple of days in the blogs of Greg Mankiw and Paul Krugman. Krugman’s blog provides the necessary background on the source of the debate:

“Greg Mankiw challenges the administration’s prediction of relatively fast growth a few years from now on the basis that real GDP (gross domestic product) may have a unit root—that is, there’s no tendency for bad years to be offset by good years later.

“I always thought the unit root thing involved a bit of deliberate obtuseness—it involved pretending that you didn’t know the difference between, say, low GDP growth due to a productivity slowdown like the one that happened from 1973 to 1995, on one side, and low GDP growth due to a severe recession. For one thing is very clear: variables that measure the use of resources, like unemployment or capacity utilization, do NOT have unit roots: when unemployment is high, it tends to fall.”

It is certainly true that when “unemployment is high, it tends to fall,” but where it falls to is not always so obvious:


Prior to the 1973–75 recession, the average quarterly unemployment rate was 5 percent. If you had a forecast contemplating a return to “normal” following this particular recession you would have been holding your breath for a couple of decades.

Professor Krugman makes the central point, I believe, when he makes reference to the “difference between, say, low GDP growth due to a productivity slowdown… and low GDP growth due to a severe recession.” That statement is, itself, recognition that the economy does periodically experience protracted episodes during which average growth and average unemployment simply do not revert to previous levels—at least not for a long time.

One of the striking things about the economic projections reported by the Reserve Bank presidents and Board’s governors in the minutes from the last meeting of the Federal Open Market Committee was the rather large variation in views about GDP growth, even as far out as 2011:


That sense of uncertainty is shared by private forecasters:


What gives? There are lots of reasons for differences of opinions, and I obviously cannot (and should not) try to divine what is anyone else’s deepest forecasting thoughts. But for me, “low growth due to severe recession” does not automatically imply a demand-driven downturn from which the economy will quickly spring back.

When I look ahead, I envision the U.S. economy over the next several years in terms of a simultaneous process of recovery and reformation: Recovery in the sense that the actual contraction of GDP will end, but reformation in the sense of structural transformation in financial markets, consumer behavior, and perhaps an adjustment of the global imbalances that are arguably at the root of much of the financial instability that has characterized the past decade.

If we are right, the long run is indeed rosy, but the long run will only arrive after some significant and protracted headwinds abate. And that is not a picture that suggests a rapid bounce back to “normal” growth.

Originally published at Atlanta Fed’s Macroblog and reproduced here with the author’s permission.

2 Responses to "Dueling forecasts"

  1. Anonymous   March 13, 2009 at 3:06 am

    I’m going to go out on a limb here and think, too. Here’s yet another forecast. Isn’t it plausible that Obama’s new economy will rise like the housing phoenix from the ashes of the dot.com bust? With a cap-and-trade carbon economy riding on top of continued sluggish private consumption and trickling returns on alternative energy peppering investor’s wallets while green building and energy conservation attract the unemployed… there is a real chance to have a spike in GDP in three years.Projecting our future through the lens of the past should produce a cause for concern. So don’t do it. The young President is cajoling the country’s youth into a sense of promise. Can’t you see it? The fight for fascism rallied the world after the Great Depression. Pushing pin stripes to topple the wall was Regan’s cry. I think that fighting climate change resonates with many. It may also be good business.

  2. Anonymous   March 13, 2009 at 8:22 am

    My concern is that there has been a sea-change in consumer behavior that will prevent a spike in GDP growth as well as a protracted high volume of unemployment in this country. This behavioral change, caused by lax credit policies and cheap interest that brought a rapid decline in home values, will prevent people (consumers) from ever being able to use their homes as ATMs. The GDP growth and employment we have witnessed coming through the last two administrations was an illusion at best. Now, people must, and are, saving; witnessed by a 5% savings rate in January. The majority of the consumption that we will see will be that required to replace worn or broken items; i.e.: the 10m+ unit/year U.S. scrappage rate for automobiles comes to mind. This level of consumption is not adequate to lower the unemployment rate any time soon.Additionally, there is the problem of the government changing the formulas to measure unemployment. We must derive a formula that cannot be altered to suit political agendas. Just like we must develop a CPI index that cannot be refuted because it doesn’t include food or fuel – excuse me? If we were to put back into these formulas the segments of the population or the categories of consumer goods that have been removed from as far back as the Kennedy administration, I would dare say that unemployment is easily double the offical number and inflation may be as well.We should have been listening more closely to the teachings of Ludvig von Mises and the Austrian School he founded. Then perhaps, all this could have been avoided. We conveniently ignore or forget that which does not create “irrationally exhuberant” consumption and false growth to suit political ends. Frankly, the level of expenditure being pushed by the new administration is tantamount to the game “Whack-a-Mole”. There is no coherant strategy and the tactics are flawed as they will not create sustainable growth and end the current unemployment. If it does, it will be based on a socialist economic model and higher taxation will lead to higher “forced” employment. The trend toward allowing unionization of every workforce is extremely dangerous. Business must not be put into a situation where it is forced to share all profits through higher wages and benefits. This will kill entrepreneurship in this country. Business must be able to grow, spend for R&D and satisfy stockholders. The policy only supports people who cannot work hard enough on their own to earn a higher wage or stand on their own two feet to negotiate a higher wage for themselves – they need someone to do it for them. If you think I’m stating they’re basically lazy, then my statement was understood. This is blackmailing our business environment and is a subject over which von Mises was very concerned – that unionization leads to continuous inflation. Eventually, like where we are now, it becomes unsustainable. US and Western European wages need to come down and approach the “global” wage. It doesn’t need to meet it, just approach it. If it gets close enough, it will forestall the push to move industry offshore to lower wage markets. Industry will not benefit in the near term from marginal cost reductions of moving offshore. And there’s always the issue of cost from moving the produced goods back to where the consumers are.Yes. I would like to see real numbers and real forecasts for all economic indicators.