The Unknown Candidate: Krugman: Gloomy Predictions

Friday, December 01, 2006

Krugman: Gloomy Predictions

I'm no economist. All I know is that in the last week alone, my property taxes went up nearly 40% (while housing prices are dropping); my health insurance premiums went up by $150 a week; the gas company, the electric company, and the cable company all increased their rates (5% to 30%). As if that weren't enough, my furnace was leaking carbon monoxide and needed replacing; my house started leaking and needed repairs; and my windows need replacing and I'm terrified to see the estimate.

Meanwhile, my household income is one third of what it was 8 years ago.

I don't know if the Krug Man is right about his rather gloomy predictions for the country's economy. But I do know how the economy of my family is doing.

And it ain't lookin' like there are any sunny skies ahead.

Economic Storm Signals
By Paul Krugman
The New York Times

“It’s tough to make predictions,” Yogi Berra is supposed to have said, “especially about the future.” Actually, his remark makes perfect sense to economists, who sometimes have trouble making predictions about the present. And this is one of those times.

We’re now two-thirds of the way through the fourth quarter of 2006, so you might think we’d already know how the quarter is going. Yet, economists’ assessments of the current state of the U.S. economy, never mind the future, are all over the place.

And here’s the bad news: this kind of confusion about what’s going on is what typically happens when the economy is at a turning point, when an economic expansion is about to turn into a recession (or vice versa). At turning points, the various indicators that usually tell us which way the economic wind is blowing often point in different directions, so that both optimists and pessimists can find data to support their position.

The last time things were this confused was early in 2001, when most economists failed to realize that the United States was sliding into recession. If that sounds ominous, it should: the bond market, which has a pretty good record of forecasting recessions, is pointing toward a serious economic slowdown next year.

Before I explain what the bond market is telling us, let’s talk about why the economy may be at a turning point.

Between mid-2003 and mid-2006, economic growth in the United States was fueled mainly by a huge housing boom, which created jobs directly and made it easy for consumers to spend freely by borrowing against their rising home equity.

That housing boom has now gone bust. But the optimists and pessimists disagree both about how bad the bust will get and about how much damage the housing slump will do to the economy as a whole.

The optimists include Alan Greenspan, whom some accuse of letting the housing bubble get out of hand in the first place. On Tuesday, he told investors at a conference that the worst of the housing slump is over, saying that “it looks as though sales figures have stabilized.”

But the very next day the government released grim data on new home sales for October, and revised its estimates for earlier months downward. Most, though not all, of the other economic numbers that came out this week were also substantially weaker than expected.

Pessimists feel vindicated by the downbeat data. Nouriel Roubini of Roubini Global Economics, who has been forecasting a housing-led recession for some time, now believes that the economy has already stalled: he predicts zero growth for the current quarter. Economists at Deutsche Bank say the same thing.

But that’s still a minority position; most forecasters are still telling us not to worry. So whom should you listen to? And how can you avoid believing what you want to believe?

Maybe the best answer is to look at what the financial markets say. Not the stock market, which is a notoriously bad indicator of the economy’s direction, but the bond market. (Paul Samuelson, the Nobel Prize-winning M.I.T. economist, famously quipped that the stock market had predicted nine of the last five recessions).

Since last summer, when the housing bust became unmistakable, interest rates on long-term bonds have fallen sharply. They’re now yielding much less than short-term bonds. The fact that investors are willing to buy those long-term bonds anyway tells us that these investors expect interest rates to fall. And that will happen only if the economy weakens, forcing the Federal Reserve to cut rates. So bond buyers are, in effect, betting on a future economic slowdown.

How serious a slump is the bond market predicting? Pretty serious. Right now, statistical models based on the historical correlation between interest rates and recessions give roughly even odds that we’re about to experience a formal recession. And since even a slowdown that doesn’t formally qualify as a recession can lead to a sharp rise in unemployment, the odds are very good — maybe 2 to 1 — that 2007 will be a very tough year.

Luckily, we’ve got good leadership for the coming economic storm: the White House is occupied by a man who’s ideologically flexible, listens to a wide variety of views, and understands that policy has to be based on careful analysis, not gut instincts. Oh, wait.

Photo Credit: Paul Krugman. (The New York Times)