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Forecasting Our Economic Future

Paul Solman: Historians sing of what has passed; journalists, of what is passing; economic forecasters, of what is to come. Over the years, and especially during presidential campaigns, we've featured the forecasting model of Yale economist Ray Fair here and on the NewsHour. Fair predicts elections as well as the economy. Today, for those interested in the future and the stimulus, he sent us this:

Ray Fair: This link has my latest 'baseline' forecast, which assumes no stimulus bill, and then a (crude) stimulus experiment:

'The stimulus has a big effect in 2010, but by 2012 the economy is roughly back to baseline (except for variables like the federal government debt). In the baseline case the federal debt rises from $5.78 trillion at the end of 2008 to $8.74 trillion at the end of 2012. In the stimulus case the debt at the end of 2012 is $9.34 trillion, about $600 billion more than in the baseline case. This does not take account of possible increases in the federal debt from the bailout activity.

So there is short run gain from the stimulus bill, mostly in 2010, but the potential long run costs do not seem trivial. If the stimulus bill is passed and the bailout continues, it may be that large tax increases will be needed starting in late 2011 or 2012.'

Paul Solman: Not being in much of a position to evaluate Fair's methodology, I sent the above to economist Dean Baker, also featured here and on the show regularly, and slated to appear in an upcoming piece about the "upside of the downturn." (Dean and I went shopping together.)

Here's Baker's response to Fair:

Dean Baker: 'In terms of Fair's model, first, he has unemployment peaking at 8.8 percent in the fourth quarter of this year. The severity of the downturn predicted by the model will hugely affect the potential benefits from stimulus and the fact that his model is generating a relatively short and mild downturn basically implies that stimulus will have little value.

The other side is the long-run story. I am not sure about Fair's model, but many macro models make little effort to incorporate the efficiency-improving benefits from public investment and education and training. In that case, a stimulus can only have negative long-run effects, since it will lead to higher debt levels, higher interest rates and therefore less investment.

On the other hand, if we think that there might be real gains from investing in energy efficiency, clean technology, computerizing medical records, then there will be a positive entry to offset the negative impact of higher interest rates.

To my [Fair's] view, I think that we are largely shooting in the dark on interest rates in a post-recovery period and the effect of the deficit/debt is likely to be swamped by other factors. I also am quite convinced that the downturn will be much more serious in the baseline scenario than what Fair's model shows (although I would be happy to be wrong on that).'

-- Posted February 11, 2009 | Comments ( ) | Permalink