Sunday, November 26, 2006

Watershed time for evolution of economic forecasting

The next eighteen months are shaping up to be quite a watershed period for the evolution of economic forecasting. For over a decade there has been this incipient low-grade "battle" between the open-minded innovators who rally around the fact that "This time it is different" and the traditionalists who rant that "No, things never change" and fall back on "historical patterns" as their rigid guide to the future path of the economy. My own view is the same as for any situation where the warring parties have staked out extreme positions: The truth is frequently in the middle.

The truth today is not that everything is the same or that everything is different, but that some things are the same and some things are different. The trick is to discern which factors have changed and which factors remain the same, and to watch as those balances shift over time.

As much as the traditionalists might want it to be, the economy is not a clock-like machine with extremely predictable behavior, but there are broad themes that do wax and wane over time, albeit without any strict clock-like frequency. Further, the manifestation of any given factor may be dramatically different from peiod to period.

The traditionalists argue two distinct prospects: 1) that there must be economic consequences to the "bursting of the housing bubble", and 2) those consequences must be very extreme. The first prospect makes perfect sense, but the great confidence of the traditionalists in the latter makes little sense. What is their primary argument for the latter? Simply: It has always been that way. It is difficult to say with certainty how the traditionalists have gotten so hung up on this desire to project an idealized version of the past far out into the future. There is usually a tone of anger to their insistence on this prospect, suggesting that some internalized source of fear is overwhelming their otherwise rational thought processes. Whatever, it is a very bizarre phenomenon. Be very careful not to get caught up in it.

As much as the traditionalists insist that there will be a profound slowing of the U.S. economy next year, there is little in the way of true economic fundamentals that could support that prospect. The economy is not a clockwork machine in which the slowing of one component dictates that all other components must also slow in a coordinated manner. Rather, the economy is an economic machine in which equilibrium is dynamically shifting on a constant basis so that resources freed up by a waning in one area can in turn fuel growth in other areas.

Not even the "best" of economists can truly begin to fathom the deep complexity of the U.S. economy, let alone the global economy. Economies are not clockwork machines produced by intelligent design, but rather are complex systems driven by evolution and the constant emergence of new businesses, new markets, new demographics, new processes, new products, new services, new ways of using resources, new technologies, and new forms of equilibrium. The traditionalists are true dinosaurs in their inability to grasp the concept of emergence and dynamic equilibrium. Even the more open-minded economists struggle mightily trying to understand the evolution of the economy.

The evolution of the equilibrium states of the U.S. economy over the coming year will humble all economists, primarily the traditionalists and their blind obedience to the clockwork guidance of historical patterns, but the more innovative economists as well who still do not fathom the true potential of evolutionary dynamic systems.

I suspect that a year from now economists will continue to utilize the same "meaures" of the economy as they do today, but I also strongly suspect that more than a few of the leading-edge economists will finally begin to ponder how to better measure the forms of dynamic equilibrium states and processes that are rampant throughout our economy.

-- Jack Krupansky

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