The forecasters and the forecasts

Hugo Lindren has just written a very interesting portrait of some of the major forecasters and their economic forecasts.  In New York I was asked a number of times about my own forecast.  I offer it with trepidation but here goes:

1. The next year will see significant recovery in terms of published economic magnitudes.

2. "Dormant inflation" will spring to life, at some point quite rapidly, and the Fed will choose to tighten.  Five to six percent inflation for a while would be OK but we will be faced with the prospect of more than that and the Fed will choke it off and prevent it.

3. We will see a "double dip" recession, with the second dip more closely resembling the 1979-1982 experience than did the first dip.  It's not just that the Fed may make an error in the timing of tightening; there may truly be no good path from here to there.

4. There will be yet a third dip to the recession, resulting from our current fiscal choices.  At some point borrowing costs will rise and taxes will go up.  There's a chance of a financial crisis for our government, especially if Chinese growth does not hold up.

5. Ten years from now, the United States will have settled into a lower long-term average growth rate, in part for policy-driven reasons and in part for demographic reasons.

6. There is still some chance that our current situation leads directly into a much bigger downturn.  This will depend on international factors, not on the internal dynamic within the U.S.

I do not put any of this forward with great confidence.

Addendum: Arnold Kling comments.


The spread between nominal treasuries and TIPS suggests much lower inflation - in the 2% to 2.5% range for the foreseeable future. Any concerns about credit quality should affect nominals and TIPS equally. There may be a liquidity premium raising nominal treasury prices, but not enough to get you to 5%-6% inflation. You may of course believe the market is being irrational.

Borrowing costs - I've seen data that total borrowing in the US has stayed relatively constant, with higher government borrowing compensating for lower private borrowing.

It'll be interesting to see how accurate you are compared to your previous forecast here:

"You may of course believe the market is being irrational."

The market has been choosing its rationalities for the last year or so.

While I am inclined to agree with your forecast, there are some point on which I disagree:

I believe we will see a triple dip but I think each successive dip will be more shallow than the previous. I also believe that, beginning in early fall, we will begin to see significant signs of recovery probably in the housing market with decreasing unemployment numbers by the end of the year. All this, of course, is based on all things remaining equal with not major shocks to the system.

Why can't the same global savings glut that catalyzed this be mucking with the bond market? Foreigners aren't irrational when they don't believe they have better alternatives. Rational doesn't mean correct. I think we will have inflation for the simple reason that they will need it. There won't be enough inflation opponents to oppose it, although Bernanke did sound some protest last week.

The short-term is difficult to predict. However, what is easy to see is that we aren't working on the right fundamentals. Why, oh why, are we not "Selling America" by promoting immigration and getting educated foreigners to buy these houses and buildings? But again, neither is anyone else being that smart, the Chinese still have nothing smarter to do with their dollars than send them here for our government to spend, so others may not be getting ahead.

Fusion: You can't calculate long-term inflation expectations off of TIPS without breaking the rates out to spot rates. TIPS traders are expecting a very low rate of inflation over the next two years and then inflation in excess of the 2-2.5% number that you quote by taking the difference of the yield to maturities.
Same thing holds for the steep yield curve. If you calculate that spot rates (treasury bonds with 0% coupons) and look at the implied 8-year/2-year Forward Rate Agreeement rate it is scary.

Shouldn't the new higher savings lead to haigher growth if the financial system can channel savings to investors? As for demography, is Tyler assuning that people retire as in the past?

If #4 were true, then Japan would be facing gigantic borrowing costs. They are not.

Their deficit is at 150% of GDP:

but their long term borrowing costs are 2.25% or so:

Clearly, there are other factors that are much more important to long term rates than fiscal policy.

The inflationary scenario (ignoring the deflationary scenarios) I apply the highest probability to is one where commodity prices advance strongly on fundamental demand. That is, in the absence of inflation, prices will still increase to a high enough level that the CPI would initially register the increase before business and consumers realized it was not temporary and slashed other spending. I see the government responding in exactly the wrong way.

in the country of the old, the one year old man is king.

"Ten years from now, the United States will have settled into a lower long-term average growth rate, in part for policy-driven reasons and in part for demographic reasons."

Perhaps you'll someday amplify on those "demographic reasons"?

There will be yet a third dip to the recession, resulting from our current fiscal choices. At some point borrowing costs will rise and taxes will go up.

When has increased taxes had a negative impact on the economy, except when the tax increases were intended to dampen economic activity. The early 90s tax hikes were followed by the longest expansion in US history and the highest rate of employment. The half dozen tax hikes Reagan signed were followed by or coincident with the second longest expansion and the second highest level of employment in US history. The tax hikes signed by Hoover in 1932 was followed by the steepest increase in employment in history, with a tax hike in 1934 as well, as I recall.

The problem in 1937 was the tax hike and government spending cut. The government spending was dominated by investment in "infrastructure" and most investment requires lots of labor with the return on that labor cost coming years and decades later. For example, the high labor cost of the Hoover Dam is still generating real return on that labor seven decades later.

I think the problem with the investment in the 90s vs the investments in the 40s, 50s, and 60s in particular, (and continuing as government programs do at the same dollar levels for decades to come) is that the infrastructure built is unproductive relative to prior investments. For example, a 3000 square foot house is less productive as an investment than a 2000 sq-ft house, which is less productive than the 1500 sq-ft house before that. On the other hand, the power generated by the Hoover Dam is worth more today than it was in 1950, as are the investments in right aways in the 50s and 60s for roads and the investments in the railroad right aways in the 19th century.


Ehm... maybe you should ask him??

I always liked this forecast from 2005:

1. I would think that Asian central banks, by buying U.S. dollars, have been driving a massive distortion of real exchange and interest rates.

2. I would think that the U.S. economy is overinvested in non-export durables, most of all residential housing.

3. I would think that we have piled on far too much debt, in both the private and public sectors.

4. I would think these trends cannot possibly continue. Asian central banks may come to their senses. Furthermore the U.S. would be like an addict who needs an ever-increasing dose of the monetary fix. This, of course, would eventually prove impossible.

5. I would think that the U.S. economy is due for a dollar plunge, and a massive sectoral shift toward exports. Furthermore I would think it will not handle such an unexpected shock very well.

6. I would buy puts on T-Bond futures and become rich.

7. I would think that Hayek's Monetary Nationalism and International Stability, now priced at $70 a copy, is the secret tract for our times.

Of course that is not me. But at least someone appears to believe in Austrian business cycle theory. By the way, here is one summary of the theory, although I do not agree with the characterization in all respects.

Posted by Tyler Cowen on January 19, 2005 at 06:39 AM

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