The Latest View from My Crystal Ball

Disclaimer - All economic projections and forecasts should be treated with extreme skepticism. Generally speaking, we are very good at projecting the future so long as current trends continue. However, we are very bad at projecting turning points which are exactly the times when you really want to know. In fact, if you take the consensus forecasts to be found in the popular press they are usually little more than extrapolations of current trends.

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Predictions for 2018 (as of Jan 19, 2018)

Here is a link to the January 19th version of my predictions for 2018!


Predictions for 2017 (Updated January 24, 2017)

Here is a link to the final January version of my predictions for 2017. Grade me on these!


Predictions for 2017 (as of December 13, 2016)

With a little more than a month since the election not much more is clear. The Fed is now virtually 100% certain to hike interest rates another quarter percent this week but fiscal policy is still anyone's guess. What isn't a guess is that there will be a debate about it, meaning that anything that passes likely won't affect the economy until the 4th quarter at the earliest. Otherwise, we are likely to see a continuation of the growth we have seen toward the end of 2016 - not spectacular but not bad either. Of course, all of this could be made obsolete if Pres. Trump follows through on some of his more extreme ideas, eg starting a trade war with China or deporting millions of workers.

Updated predictions:

GDP -  2.5 – higher at the end of the year if spending is high
Unemployment –  4.5 - 5%   
Inflation – Not a worry. 
Interest Rates -  1% this time next year - up to 1.5% if growth continues

Exchange Rate - Dollar will continue strong as interest rates rise

Predictions for 2017 (as of Nov. 10, 2016)
Two days after the 2016 election is a bad moment to try to be precise about the future of the US economy.  It is not yet entirely clear what Mr. Trump intends to actually do in terms of economic policy since it is obvious (to me at least) that he can’t fully follow through on the many things he claimed he would do during the campaign.  Nevertheless, it is clear that he will be advised and assisted by Republicans who now control all branches of government.  Though quite a few “trumpisms” are in opposition to long-held Republican economic beliefs, it is worth trying to make a prediction based on some combination of Trump promises and standard Congressional Republican economic policies.

It is also worth stating what I was wrestling with before the election in terms of a one-year-out prediction:  namely, some indicators are now looking like they are close to a cyclical peak while others do not.  This means it is time to at least start wondering when the next turning point will be, and that question remains with us regardless of the outcome of the election.  Where I came out on this question on Monday prior to the election was that even though a cyclical peak might occur sometime later in the year, our economy has enormous inertia and so the economic numbers will not really respond in any big way to the change in leadership until late in 2017.  Just as Obama was not responsible for the first few quarters of recession when he took office in 2009, neither is Trump responsible for whatever will happen in the first few quarters of next year.

First, however, is the question of how I did on my predictions a year ago.  At that time I said the following:

GDP -  2.0 – lower if rates go up more than once.
Unemployment –  5%   
Inflation – Not a worry. 
Interest Rates -  1% or less (probably less) this time next year

Fiscal Policy – Always the big uncertainty. But likely to continue with spending flat and        therefore a gradual tightening in percentage terms

I was quite accurate on all of these except GDP where I was a bit optimistic.  I said it would grow at 2% and so far it has only been 1.5%.  However, the advance 3rd quarter reports are quite strong so I may in fact end up correct by the end of the fourth quarter.  All in all I give myself an A minus!!!!!

In terms of where we are now in the business cycle, the big question is the labor market.  While a headline figure of 5% is likely to be close to the low point and therefore close to a cyclical turning point, other measures of labor market tightness are less clear.  Broader measures of unemployment such as U6 remain stubbornly high while wage inflation remains muted though trending upwards this past year.  The broadest measure of the labor market, the ratio of employment to population (emratio) remains well below previous peaks but this may or may not be an indication of a “new normal”.

The housing market looks like it may well have returned to something approximating “normal” with price to rent ratios back in normal ranges.  Also back in historical ranges are new home sales and months of supply of new homes.
Industrial production certainly looks like it could be showing us a peak but on the other hand it is still lower than the previous peak and capacity utilization is in the mid 70’s.  Add to this the fact that coincident and leading indicators on the state level look mostly OK.  Though there are a couple of trouble spots these are not big enough to dominate national level stats.  All of this is very much a mixed bag. 

In terms of economic policy, we are still very expansionary on the monetary side with short interest rates well below 1%.  The Fed has stated that they will be guided by their target inflation rate (2% as measured by the Personal Consumption Expenditures index) and the latest reading of 1.7 is still below that target.  Nevertheless, expectations are that the next move will be up and we can expect another quarter percent increase in the first half of the year if not the first quarter.

Fiscal policy remains bogged down in the paralysis that Congress has been mired in for the past several years.  This means largely flat spending levels in most areas which, as noted above, means a gradual progressive tightening in percentage terms.

The outlook for the next year depends on whether we really are close to full employment.  If so, expect a faster pace of Fed tightening.  On the fiscal side, now that Republicans control Congress we ought to see efforts to cut spending, though Mr. Trump himself has a long history of willingness to spend borrowed money to make large investments.  But even if this happens, the results won’t be immediately apparent.  In the meantime, our ability to respond to potential unforeseen negative shocks remains nil.  Monetary policy has no scope for further stimulus while fiscal policy is dependent on political willingness to spend money which may or may not materialize.

With respect to Mr. Trump’s stated intention of raising tariffs, deporting millions of undocumented immigrants and repealing Obamacare, all of these would be negative shocks to the economy.  Again, the results would not be immediately apparent though we can expect rapid retaliation from trading partners if, e.g. Trump were to unilaterally impose tariffs on China as he has promised.

All of this means you should assign a much higher margin of uncertainty to my forecasts this year -  Here is what I am predicting:

  1. GDP growth at 2.0%;
  2. Unemployment 5%
  3. Inflation – Still not a worry, likely to be around 2%
  4. Interest rates – Fed will likely allow a rate increase or two in next year – but only a ¼% at a time – We might reach 1% at short end by a year from now
  5. Fiscal Policy?  The big question; ask me again in January
  6. Exchange Rate:  Higher interest rates mean a continued strong dollar which will help dampen inflation but also commodity prices


Predictions for 2016

The narrative for my 2016 predictions was eaten by the internet! In keeping with my policy of never writing predictions ex post facto I will only post things I wrote/presented at the time and not try to reconstruct now what I thought then. Here is the Powerpoint I presented in December of 2015.

Prediction Update as of August 25, 2015

Though it is perhaps a bit dangerous to make predictions after several days of wild swings in world stock markets I will, as usual, make my caveats and plunge ahead anyway.

Overall, it is clear that the major sources of uncertainty are overseas but the US economy remains fairly steady, continuing its gradual climb out of the recession of 2009.  China and Europe are the main problems of the moment but pose rather different risks:

  • Europe remains wedded to its policy of fiscal austerity as the panacea for budget deficits.  Since fiscal austerity is not in fact a panacea for budget deficits and in fact tends to make them worse and not better, we are likely to see a continuation of stagnation in the EU.  Since the EU as a whole is comparable in size to the US economy this represents a large fraction of world output and world demand and will dampen any upside potential from elsewhere.  The Greek tragedy is emblematic of their problems:  Even though many observers (including yours truly as well as those wild-eyed radicals at the IMF) don’t believe the latest bailout has any chance whatever of succeeding without a substantial writedown of debt, the German-led powers that be insist on staying the course.  The Greek economy itself is not big enough to make a difference to the US but the latest round of “negotiations” can’t help but make one nervous over the future ability of the EU to provide a happy home for all of the economies and political parties it contains.  Fragmentation in the EU would be a good bit more problematic for the rest of us than mere stagnation and while I am not predicting a major breakup in the near future it is not a good thing that it is even a topic of conversation.
  • China’s stock market is the proximate cause of the current financial instability and it is no real surprise.  What IS a surprise is that Communist government of China could be so clueless as to imagine they could prop up a stock market that was way overvalued.  Once they started rinkydink policies like forbidding state companies to sell stock, or trying to buy stock on their own account it was only a matter of time before the dam broke.  Certainly it isn’t a good thing but here in the real world we know that China is only a small portion of the world financial picture and if they and their exchange rate management are more closely aligned with market forces in the future then that is likely to be a positive thing.

So, how about the US?  Apart from the obvious sympathetic stock market movements we are seeing a continuation of our growth of the past several years.  The stock market – even at a thousand points down from its peak – doesn’t look overvalued from a P/E ratio point of view and interest rates are back down near their lows.  The current kerfuffle should put to rest any idea that the Fed will raise rates in their next meeting.  Ignore any commentary to the contrary, but if I am wrong about this then you should be quite worried as it will be a sign that economic policy is becoming divorced from fundamentals and that your bias should be to get out of the market.  However, I have a much higher opinion of Janet Yellen than that so I am not too worried.

Unemployment in the US is 5.3%, continuing its gradual downward trend.  Happily, this is not seeming to cause any wage pressure whatever, and inflation is as low as anyone could wish for.  If the Fed is waiting for signs of inflation to raise rates then they will have to wait a while longer. Another factor is energy and commodity prices,   These are bottoming out in cyclical terms and are another reason we are seeing no inflationary pressure.  With oil under $50/bbl we might well see a resurgence in sales of huge personal vehicles on the roads but we sure won’t see a dampening effect on growth outside of states that are dependent on energy production for their output.

Gradual declines in unemployment are joined by moderate but not spectacular growth.  The first quarter of the year saw 0.6% increase in GDP (weather was a problem).  The second quarter saw an increase to 2.3% - still below my previous prediction but not out of line with recent trends.

Housing continues to gradually recover with nominal prices now close to their previous peaks.  Sales of new homes continue to improve though they are still near what would normally be considered cyclical lows.  That is a testament to how flat on the ground housing construction really was in the aftermath of the 2009 collapse.  Inventories of homes for sale are at normal levels of a bit below 6 months – a further sign that the market is stable and on the road to recovery.
What about my predictions?  I continue to be spot on with my statement that inflation is simply not an issue.  Likewise, my continued worries about Greece and the EU are proving to be well founded.  Unemployment is gradually drifting down as predicted but growth is more sluggish than I thought it would be.  Part of this is due to the terrible weather of last winter so there is still time for my prediction of last Spring to come true.  Let’s all hope so, because I really do want to get an “A” for my predictions this year!


Update - Mid-March 2015

My predictions of three months ago are largely intact. In terms of inflation we continue to undershoot the Fed's 2% target and may in fact be going quite a bit lower as the recent producer price index release showed a decline. This, coupled with the lack of any signs of wage pressure, means that it is unlikely the Fed will start to raise interest rates in the immediate future. Indeed, there is no reason not to believe Janet Yellen when she says that she wants to wait unitl she actually sees signs of inlation before initiating a rate increase. Two external factors that will help to keep inflation down are the strengthening dollar (or perhaps we should say the collapsing Euro) and lower oil prices.

In terms of fiscal policy, Congress is just about as dysfunctional as any cynic would have predicted three months ago. What that means is probably a series of last-minute continuing resolutions which keep fiscal policy on the same course - very slowly rising in absolute terms but falling spending as a ratio to GDP or population.

My prediction of 3% growth in GDP still looks pretty good, as does my 5-5.5 prediction for unemployment.

Europe continues to be the big wild card in any macro prediction. The recent "agreement" with Greece was vague enough for all parties to claim victory. Once they realized this, they backed off of their happy talk and are back to arguing about austerity. The Greek population (and the Irish, Spanish and Portuguese) can only hope they stop promoting contractionary policies since unemployment rates in the 25% range can cause serious damage if they go on long enough. There is still a real chance that Greece could leave the euro and a worst case would include a domino effect for other countries. However, the likeliest outcome is still that the Europeans will find a way to kick the can down the road yet one more time as they have been doing for 5 years now.

You can find a link to the powerpoint presentation for these predictions here.


Predictions for 2015

For the second year in a row I gave myself an A-! Most of my predictions were pretty good. The exception was unemployment, which I thought wouldn't get below 6% (and in fact said it would be between 6-6.5) but it came in at 5.8%. My mistake was thinking that an improving economy would lure more discouraged workers back into the labor market. They didn't and whether or not they ever will is a subject of current debate. Inflation and interest rate predictions were spot on (pegged at zero for interest rates and below 2% for inflation). My prediction that THIS would be the year Greece finally got tired of 28% unemployment was wrong for the second year in a row but I won't make that mistake again!

This year I continue to be optimistic and think GDP should grow at 3%. Inflation will continue to be low though we should be looking for signs that wage inflation is picking up as a guide to when the slack in the labor market is at an end. Consumer debt service is now well below historical levels as a percent of income - Further credit expansion is indeed possible subject to banks' willingness to loan to any but the absolute best credit risks. Industrial production is steadily rising and capacity utilization will hit 80% some time this year which should spark some renewed business investment.

Fiscal policy is likely to remain frozen given the Republican gains in Congress and the lack of any real rapprochement with the Obama White House. This means it will slowly become more contractionary (i.e. the deficit will gradually shrink as a percentage of GDP) as the economy grows but spending doesn't. The only real danger here is another outbreak of Congressional insanity leading to a shutdown of the government for some reason. We should all hope this doesn't happen but it would be hard to be 100% sure it won't.

Monetary policy continues to be expansionary though there has been an end to Quantitative Easing. The market expects short rates to start to rise again around the middle of the year. That is a reasonable guess but the Fed should only do this if wage inflation is excessive, which means higher than the upper end of their target range of 2-2.5%. Even so, short rates are unlikely to top 1% by a year from now.

The biggest potential caveats to the rather upbeat forecast are if the Europeans have a major problem or if China does. The Europeans continue to have wide disparity in national unemployment rates (around 5% for Germany and above 25% for Spain to take an example) which means that the "optimal" policy for one country is very clearly not optimal for all the others. Whether this causes major dislocations is really a political question. I am not predicting that this will happen but the fact that it is even a possibility is unfortunate. As for China, it is difficult to have any precision due to the poor quality of the data we have, but the fact that they have seen an end to their real estate boom and a decrease in growth in export demand has to mean there are adjustments being made. Whether their large underground economy will weather this without hiccups is a question mark. However, there is only a small chance that this will significantly impinge on the US within a year.

So, overall the predictions for the coming year are : growth at 3%, unemployment at 5-5.5%, inflation still not at all a problem, interest rates 1% or lower (probably lower) by the end of the year, and fiscal policy gradually becoming more contractionary as Congress is unable to do anything but continue spending at something close to current levels.

A link to the outline of my presentation can be found here and a link to the powerpoint slides can be found here.

Predictions for 2014

Grading my predictions from one year ago, I gave myself an A-! Pretty much every prediction was spot except for my expectation that Greece would finally have had enough of austerity and would have provoked a Euro-scare by leaving the currency rather than continuing in their endless depression.

This year I am turning optimistic and am predicting an increase in GDP growth to around 3% and a corresponding drop in unemployment to the mid 6% range. Inflation will continue to be low.

There are a couple of reasons why I am now more optimistic. Two in particular stand out: Consumer debt service has now declined to below historical averages as a percent of income, setting them up for continued expansion of consumption which will support retail sails. Second, the housing market, as predicted last year, did indeed find its bottom and has now started to turn around. It is still at very depressed levels but there is plenty of room for growth in an economy where the population is growing and unemployment continues to fall.

The appointment of Janet Yellen to succeed Ben Bernanke as Chair of the Federal Reserve is a welcome development in that she is both highly competent and has announced that she intends to continue to the current Fed policy of aggressive expansion until a visible economic response is seen. The Fed may well initiate a tapering of their long term bond buying program which would mean a rise in long term rates but are unlikely to allow short rates to rise through the coming year.

Fiscal policy is, of course, more of a question mark given the non-reality-based elements in Congress who are entirely willing to hold the government hostage to their demands. However, I am predicting that in an election year they will be reluctant to push the government back into outright paralysis and so we will see a continued mild contractionary stance in terms of overall fiscal policy. This is, of course, not a good idea since what the economy needs most from Washington is a strong fiscal stimulus aimed (in my opinion) at infrastructure and aid to state governments, as well as a hike in the minimum wage.

The minimum wage has surfaced as a political issue, given the fact that about half of fast food and retail workers get some form of government assistance, as well as a third of bank tellers in addition to many other full time workers. With corporate profits at record highs it is hard to justify subsidizing them in this way, particularly when empirical research into minimum wage hikes indicates that there are few if any adverse consequences.

Major downside risks for the next year continue to be led by the chance of a European meltdown though after my failed prediction that Greeks would have had enough of 27% unemployment by this time, I am not going to make any predictions on that score. Some observers have raised the specter of another stock bubble after the recent runup in stock prices but my crystal ball doesn't have enough clarity to predict such a thing though graphs of the S & P 500 over recent years do look a bit suggestive.

A link to an outline of my presentation can be found here and a powerpoint presentation with the accompanying graphs can be found here.

Predictions for 2013

Last year's predictions turned out to be quite accurate! Let's hope this year's are less so, because I am predicting continued slow growth in the 1-2% range as the economy gradually works off its excess debt and the housing market begins to return to normal.

The economy would be quite responsive to a fiscal stimulus under current conditions (stubbornly high unemployment and zero interest rates) but political obstacles make it highly unlikely that we will see this happen. In fact, the best we can hope for is fiscal neutrality in a political atmosphere seemingly obsessed with cutting the national deficit in the short term. A far better approach to cutting the deficit would be to turn all of those unemployed people into taxpayers by hiring many of them to rebuild our decaying infrastructure at a time when we can borrow money at negative real interest rates but I just don't see this happening. Even with the example of renewed European downturns in response to exactly the deficit cutting policies promoted by conventional wisdom in Washington, it seems unlikely in the extreme that a jobs/expenditure bill large enough to do the trick could make it through Congress.

On the bright side it is likely that we are looking at the bottom of the housing market and that it will gradually improve through the coming year. Prices have already started to rebound a bit and inventories are now down at levels which can support an increased level of new construction. However, given the extremely low level we are rebounding from, we can't look for housing to lead us out of the recession very quickly.

Given all of this it is likely that unemployment will drift downward only slowly, reaching maybe the 7% range by year-end as slow growth and reentry of discouraged workers into the improving labor market prevent sharp declines in this figure.

Inflation and interest rates will both hover at record low levels for the coming year - Inflation will remain low because the economy is growing only very slowly while interest rates will remain low because the Federal Reserve will keep the short end near zero by design. Long rates will also remain low as a combination of low short term rates and slow growth prospects combine to prevent increases.

The big wild card this year is Europe. I believe Greece will finally depart the Euro this year or else it will cease to be a functioning democracy as popular resentment at austerity reaches a level that will make the current policy untenable. Though it is possible for the German led EU coalition to prevent this with substantial debt reduction and aid it is hard to see this happening, at least before the September German elections. If other bigger European economies reach crisis mode (i.e. are forced into a default on their sovereign debt) then all bets are off and the world will be in a financial crisis whose outcome we can only guess at.

You can find an outline of my presentation here. The associated powerpoint presentation is here.


Predictions for 2012

After taking a sabbatic in 2011 (the first in 24 years) I am back to my predictions for the coming year. My predictions for 2010 made in December of 2009 were not quite as accurate as those in the previous year. My reasoning was OK but my timing was off - My expected slowdown from the winding down of the stimulus didn't happen until 2011. The real estate market is indeed still weighing on the economy but my prediction for continued low interest rates and inflation were quite good. Overall, I gave myself a B+.

For 2012 I am predicting continued slow recovery from the recession (1-2% growth in GDP). We have now come a long way toward completing the portfolio adjustment that was long overdue in the private sector - Household debt ratios are back to normal ranges though consumers are not "at the end of their leashes" wanting to go out and pile on more debt. This is due both to continued high unemployment, low housing prices, and continued pessimistic consumer sentiment. We can expect some improvement in unemployment through the year, with a year-end rate in the vicinity of 8%.

A major wild card for the coming year is what happens in Europe. While the Greek fiasco fits the narrative of a government spending way more than it ought to have, the stories in Italy, Spain and other countries is rather different. Indeed, Spain was actually running a SURPLUS right up to the onset of the crisis and got caught in a Florida-like real estate crash rather than a government caused debt overload. What this means is that German insistence on fiscal austerity not only misses the mark as far as identifying the root cause of the problem - It is likely to make the situation worse rather than better as austerity causes economic contraction, higher unemployment, and therefore additional pressures toward deficits. This sort of scenario is going to create intense political pressure to find another path and it is my opinion that sooner or later the Greeks will go ahead and take that path - default on their debts, leave the euro, and devalue sharply so as to restore competitiveness. Even larger economies may well face the same dilemma - Spain ALREADY has an unemployment rate of more than 22%. It is hard to imagine that deeper austerity and contraction will be politically palatable for very long.

What this means for us is that the world economy as a whole is facing a sharp "negative stimulus" as the Europeans contract and the US winds down what remains of its own stimulus. In addition, if there is a run on European banks, there could well be a contagion effect here in the US. While a European collapse will take some months to translate into US GDP and employment figures, it could well cause problems in the financial sector more quickly.

Another result of the European uncertainty is a major uncertainty in my exchange rate prediction. With the Euro trading around $1.30 there is clearly room for movement downward if the zone starts to break up. But if indeed the Euro zone contracts to its "hard money" core a stronger (though smaller) currency could emerge in the longer run.

Your can find an outline of my presentation here. You can find a link to my powerpoint presentation here.

Predictions for 2010

My predictions from a year ago have largely come true though I wasn't quite gloomy enough compared to reality to hit it right on the nose. But I was close enough that I gave myself a pretty good grade. Next year will be a bit tougher since there are numerous factors that could go either way, making it advisable to take anything I say with a pretty big grain of salt.

My predictions are based on the assumption that monetary policy will remain at the extremely loose end of the spectrum with short interest rates near zero for the entire year and that fiscal policy will be expansionary but the deficit will be substantially smaller than the $1.4 trillion we saw last year. Personally, I wish they would pass another stimulus since we obviously need it but I am afraid the politics to make that happen just arent going to work. As always, I am making predictions based on the assumption that there will be no major unforeseen shocks since, naturally, we can't foresee them.

Overall, I am calling for anemic growth in the 1-2% range. This level of growth won't technically be a recession but neither will it be enough to make much of a dent in unemployment, which I think will be in the 10-10.5% range a year from now. The main problems coming out of our current slump are the fact that consumers are still working off the mountain of debt they have accumulated, something that is all the tougher to do when employment numbers are so dismal. Business investment can't be expected to provide much of an impulse until capacity utilization rises from its current levels of around 70%. And the government, as noted above, is going to retreat somewhat from the massively stimulative posture of 2009 though they will still be somewhat expansionary. We can't expect much help from abroad through exports since this recession is worldwide.

Housing will continue to be a drag on the economy through next year with more bad news likely. Not only is commercial real estate following the usual pattern of dropping a year or a year and a half after residential real extate, but there is still a big backlog of foreclosures and delinquencies that will keep the inventory of unsold houses well above "normal" levels. In addition, we can expect yet more delinquencies and foreclosures as unemployment continues to take its toll and as some of the less advisable excesses of the real estate bubble (e.g. option ARMS) reach the point where they convert to conventional mortgages.

Inflation is not a worry at the present time in spite of the paranoia of gold bugs and others who have noticed the huge monetary expansion. They neglect the fact that the monetary expansion doesn't even come close to filling the hole created by the various market meltdowns of the past couple of years together with the vastly increased desire for cash and near cash instruments on the part of the public. Unwinding the current position of the Fed will be interesting but we aren't at that point yet.

Exchange rates should continue to drift toward their previous levels of 1.60 vs. the Euro while the yuan/dollar rate will continue to change at a pace only visble to those with microscopes. Our trade balance should gradually improve barring major changes in oil prices.

An outline of this year's talk can be found here. The powerpoint presentation that went with it is here.


February 28, 2009 Update

In a presentation at the end of February I noted that the predictions made in December were still pretty accurate but that we were likely to be looking at the bottom end of that range. As expected, 4th quarter growth was very low and preliminary readings on retail sales, unemployment and other indicators show further very bad news with still more likely to be on the way.

The prediction of at least 8% unemployment came true today (March 6) with the further prediction of 9 or even 10% not being out of the question still looking accurate. As predicted, housing prices have continued to drop like a rock and commercial real estate is indeed following suit. However, the less securitized nature of commercial mortgages together with their smaller total (a bit under 25% the amounts in residential real estate) means that the negative shock from this decline won't be as big as that from residential real estate.

The stimulus plan as passed by Congress is good, but too small in and of itself to do what is needed. At a bit less than $400 billion each for this year and next it amounts to a bit less than 3% of GDP, well under what most observers (at least those who believe in the concept of a stimulus) would think is needed. As a benchmark it should be noted that deficits as a percentage of GDP peaked at around 25% during World War II and while that might well be excessive at the present time it is obvious that there is plenty of room for a bigger stimulus.

Fortunately, the President's budget proposal provides just that. If passed more or less as proposed, it would provide a jolt of a bit more than 10% of GDP, which is in the range of what is needed at this point.

Less clear, however, is the adequacy of the proposals for rescuing the banking sector. Most of the proposals floated by the Administration so far revolve around buying (or inducing the private sector to buy) the toxic mortgage assets from the banks. The problems with this are many, among them

- There is presently not much of a market in these securities and hence no good idea of a market price

- It is hard to imagine any private sector entity actually wanting these assets at a price that would leave the banks solvent. Either they pay too much and save the banks at their own expense or they pay too little and don't solve the basic problem of insolvency that the banks are facing.

- Efforts to pump up the prices of these assets are unlikely to succeed. They may well be worth more than what the market is discounting at present, but we wont know that for quite some time to come - That is, the only way the mortgage backed assets are worth as much as we would like them to be in a rosy scenario is if the stimulus and financial rescue packages are successful at restarting growth and therefore reducing foreclosures. Apart from the obvious chicken-egg problem in this, even under good circumstances it wont work out for several years - and we dont want zombie banks staggering along for that long.

What to do? I believe the inevitable will have to be faced at some point this year and the sooner the better. The larger zombie banks deemed too big to fail (Citi, BofA, etc.) need to be taken over, stripped of their toxic assets, recapitalized and sold back to the private sector. The virtues of this are that the banks would quickly be relaunched without a question mark hanging over their long term survival, and the government could recoup a large part of the cost of eating the bad assets and recapitalization from the proceeds of the sale, Furthermore, it would avoid the problem of using tax dollars to bail out bankers and stockholders who have gained massively from the profitable years of the mortgage bubble, but are so far escaping the usual consequences of making decisions that result in bankruptcy. Going forward it is very important that decionmakers think twice and three times before doing things that put not only their own institutions, but the whole financial system at risk.

In terms of growth, we are still on track for the pessimistic end of Decembers predictions of 2% decline but worse if the stimulus package is too small (so far it is) or if the banking crisis is not resolved (which so far it isnt).

The dollar continues in the range it was in last December (in the high 1.20's against the euro) and it is still hard to see it strengthening further from this point, though some amount of weakening is not unlikely at some point when the current flight to Treasury assets abates.

The powerpoint presentation for this talk can be found here..

Predictions for 2009

I predicted last year that 2008 would be a slow growth year in the range of 1-2% "unless the credit crunch gets ugly" in which case it would be lower. This has proved true with growth through the third quarter in the 1-2% range and clearly set to be lower in the fourth quarter as the economy moves into recession.

There is no doubt that the popping of the housing market bubble and consequent collapse of the credit markets built on the basis of various types of mortgage backed assets and derivatives has spread well beyond real estate by now. Nevertheless, we have yet to see the bottom of the real estate market: Housing prices still have not fallen into normal historical ranges of ratios such a home prices to income or prices to rent while commercial real estate is only now starting to decline. The continuation of this into next year will provide further downward impetus as the economy contracts.

Credit markets remain frozen up as paranoia runs rampant through the banking industry and individual banks work hard to restore their balance sheets to a stronger position. Given the reluctance of banks to lend and of customers to borrow it will be some time before normalcy returns.

Consumers have at long last realized how overextended they are and household debt ratios have declined for the first time in a long while. This retrenchment means very weak Christmas season sales and with stagnating or declining personal incomes coupled with there is no reason to think that consumers can be the engine of recovery Industrial production has started downward as well, largely in response to declining demand, making it extremely hard to forecast any recovery of business investment in the near future.

Given the fact that neither consumers nor business can be expected to provide the spending needed to lead us out of recession, it is up to government to provide a stimulus. Given the fact that interest rates are near zero (0.005% yield on 3 mo. Treasuries last week) we are in conditions somewhat reminiscent of 1932 - only government spending is left as a potential tool to stop the downward spiral. A stimulus package should be large (resulting in a fiscal deficit on the order of 10% of GDP) since there is ample scope for monetary policy to slow things down if need be, and we don't want to have to try again after another too-small attempt to stimulate the economy. It should be targeted at areas where the money will be spent quickly (extending unemployment, aid to state governments, immediately implementable infrastructure projects, etc.) since there is a high probability that taxpayers will simply save tax cuts and businesses will not borrow even if credit markets loosen up since demand is falling.

The success of any stimulus hinges on how fast it can be done and if it is large enough - President elect Obama is likely to have at least something of a honeymoon period to get things through Congress and the accuracy of this forecast depends on the rapid passage and subsequent success of his proposed package.

The best that can be expected in 2009 is no growth at all. Far more likely is a decline of 1-2% in GDP, with even worse performance if there are additional negative shocks or if the stimulus package is delayed or too small to be effective. For those wanting to get really depressed, a worst-case scenario would have foreigners and domestic investors resisting additional federal debt, pushing up interest rates and thereby squashing any potential positive effect of a stimulus. However, given that even a large stimulus would leave the debt/GDP ratio well below historical peaks this probably won't happen, particularly given the appetite for Treasuries evinced by nearly everyone in the current crisis atmosphere.

Given the growth projection above, the current 6.7% unemployment will easily reach 8% next year with 9 or even 10% not out of the question depending how good or bad the growth performance is. Inflation is not something we need to worry about. Deflation is even a possibility though not likely given a large stimulus package. The stock market is anyone's guess - stocks tend to recover sooner than the real economy but the only prediction I will make is that there will be very high volatility in the year to come as investors struggle to figure out which way the economy is heading.

The value of the dollar has strengthened in the past few months as investors worldwide have flocked to US Treasuries but it is hard to see it strengthening much more than the current mid 1.20's against the euro. The huge flood of US paper hitting the markets will tend to weaken the dollar over the next year but the fact that interest rates can only go higher in the future will limit downward movements to some extent.

An outline of this year's talk can be found here. The accompanying powerpoint presentation can be found here.

Predictions for 2008

Last year's prediction that we would see the peak of the business cycle in 2007 seem to have been borne out as well as the prediction that the bursting of the housing market bubble would figure prominently in the turnaround. Predictions of further dollar weakness were also borne out with a steep drop vis a vis the euro and some evidence of foreign central bank reluctance to continue buying dollar assets at previous rates.

Accordingly, 2008 is forecast to be a recessionary year for the economy with growth in the area of 1-2% and possibly lower if the credit market crisis can't be contained. This is a real possibility with housing prices already down 7% from their peaks and foreclosures at record rates. The housing market will only come back into balance when house prices fall enough and/or inflation rises enough to restore normal ratios between house prices, rents and incomes. This is unlikely to occur within the next year.

Inflation is likely to be on the high side next year, probably around 5% as oil price increases and dollar depreciation continue to work their way through the economy. Opposing forces are also at work since a severe slowdown would dampen price increases to some extent. Where the dollar goes from here is hard to say - While the long run equilibrium for the dollar is pretty clearly closer to 130 than 1.50 to the euro it has yet to fall substantially vis a vis some other currencies, notably China and Japan.

The Fed will have a balancing act over the next year as credit market mayhem will make them want to lower rates while inflation and dollar weakness will work the other way. However, the Fed will always put domestic considerations before international ones and system stability issues before anything.

Congress can be counted on to do pretty much nothing at all in an election year. There is some possiblity that the Alternative Minimum Tax could be "fixed" but even that isn't a certainty. So, look for paralysis in Washington until a year from now.

An outline of the talk can be found here and a powerpoint presentation with the graphs used to illustrate it can be found here.

Predictions for 2007

From the vantage point of early December 2006 it looks like we are now past the peak of the business cycle that began some five years ago. The Fed campaign of tightening is probably at an end (market expectations are for a rate decrease in March) and while the Democratic takeover of Congress has improved the long run fiscal outlook (those recent tax cuts will likely be allowed to expire by 2010 rather than being made permanent as the President wants) the near term outlook is still for huge deficits.

The housing market was the engine of the expansion over the past few years and the end of the housing boom is what is causing the turnaround in the overall business cycle. Various pieces of evidence point to a peak in housing earlier in 2006 and we are now left to hope that the air goes out of the bubble slowly rather than all at once. Either way, with house price appreciation slowing (or even going negative) and household debt service ratios at record highs there is little scope for consumer spending to prolong the economic expansion.

The European area is continuing to undergo a tightening cycle in monetary policy so there is little help to be expected from that direction while the Chinese economy continues to grow at very high rates. This can't continue forever but there is no particular reason to name a date when it will end. The big danger is that the Chinese central bank will decide to stop buying US government debt which would cause a drop in the value of the dollar. With dollar holdings already in the vicinity of $650-700 billion they could decide to expand in other directions. This would be significant for the US economy, providing additional downward pressure on the already weak US Dollar (now at 1.33 to the Euro) and upward pressure on interest rates.

Predictions for the coming year are: GDP growth around 2% (lower if there is a major political or economic shock) inflation continuing around 3% and interest rates likely to come down (at least at the short end) gradually through the year.

An outline of the talk can be found here and a powerpoint presentation with the graphs used to illustrate it can be found here.

Predictions for 2006

The outlook for 2006 is one of considerable risk depending on several factors affecting the economy. As the Fed continues its campaign of tightening the possibility of a yield curve inversion is very real and could signal the beginning of a slowdown or recession. While Congress cannot be expected to control spending in an election year, more tax cuts are less likely than previously so that our continued descent into ever increasing indebtedness is likely to continue. The question remains as to how big an appetite the foreigners have for our paper - If they decide to stop buying it as readily as they have so far it could mean sharply higher interest rates and a deeper slowdown than we could otherwise see.

Oil prices are another major unknown. They remain much higher than in recent years though they have retreated from spikes in the Fall. Nevertheless, higher oil prices will tend to put the brakes on the economy and consumer sentiment as will higher interest rates.

Political weakness has meant the end of the Social Security proposal of last year (something we should all be thankful for) as well as the tax reform plan. Indeed, even political strength would have been unlikely to make that pig fly since politicians who want to be reelected don't vote to abolish the home mortgage interest deduction.

All things considered, the outlook for next year is 3% growth (higher at the beginning of the year and lower later) and continued moderate inflation barring another major oil price increase. Interest rates are likely to continue higher at the short end, while longer rates will likely respond to a combination of factors including the level of economic activity and the willingness of foreigners to keep funding our deficits.

An outline of this talk can be found here and powerpoint presentation here.

Predictions for 2005

The outlook for 2005 is one of continued unspectacular growth with a significant downside danger stemming from unchecked fiscal and current account deficits. While I called for 3% growth over the coming year, I remain very worried that an exchange crisis could provoke interest rate spikes which would in turn cause a major correction in capital markets and a sharp retrenchment for debt-exposed consumers. It would also result in a much slower growth of the economy overall. Therefore, we should all hope for the alternative scenario of a gradual dollar depreciation and a renewed commitment to fiscal discipline in Washington.

Unfortunately, the White House has espoused policies seemingly designed to exacerbate this problem, including but not limited to: making the previous tax cuts permanent, Alternative Minimum Tax relief, using borrowing to fund the $2 trillion financing gap caused by the Social Security privatization proposal. These, together with conservative estimates of discretionary spending growth yield federal deficit projections that grow continuously as far as the eye can see. As long as this continues the chance of an unpleasant correction (a "hard landing") will grow.

Barring major exchange rate changes, there is little pressure on inflation given still low levels of capacity utilization and a still soft labor market. Interest rates are headed back up though they are still at historically low levels. Again barring exchange rate problems, look for increases on the order of 2-3% over the next year.

Notes from my December 7 talk can be found here. A powerpoint presentation containing graphs and charts for my talk can be found here.

September 2004 Midyear Update

Below are last December's predictions. In September of 2004 they don't look bad - the growth prediction of 4% is perhaps a little high but not seriously off base. As predicted, inflation has not come back, while interest rates are indeed slowly on the rise again. The dollar has not fallen, and has remained in a trading range pretty much where it was last December. The stock market hasn't gone up or down much from where it was.

I am now predicting that growth will continue but at a rather plodding pace of 3% or perhaps even a little less next year. Inflation won't spike unless there is a serious depreciation of the currency and/or oil prices spike substantially. This is because there remains lots of slack in both labor and capacity utilization. The biggest threats are an oil price rise from unforeseen events; a serious consumer retrenchment if spending reacts negatively to interest rate increases in the face of massive debt increases over the past three to four years; a dollar depreciation if foreigners get tired of buying all of our paper.

These predictions were made in a speech in Orlando Florida on Sept. 20, 2004.

Predictions for 2004

Once a year in December I make a public statement of my best guess for the coming year at Cornell's annual Outlook Conference. In December 2002 my talk predicted continued low growth (on the order of 1-2%) with various factors which could influence outcomes as we go along. As things turned out, I was too low in my prediction due to the far larger stimulus than I expected, the continuation of interest rate cuts, and the willingness of consumers to continue piling on debt at an unabated pace.

In December 2003 my talk predicted better growth prospects for the coming year (around 4%), based on the apparent turnaround in the third quarter of 2003, the apparent willingness of the Federal government to run even larger fiscal deficits in the coming year ($375 billion in 2003 and forecast for $500+ in 2004), and the lack of any pressure to raise interest rates in the near term. Most traditional indicators of the business cycle point to an improvement in conditions in the near term.

However, there are reasons to be cautious as to the pace of the recovery. Among the things to watch out for:

- Though unemployment seems to have turned the corner we still have yet to see a convincing turnaround in actual hours worked, which is what puts money in peoples' pockets

- Consumers will have to get the money from somewhere if the recovery is to continue and consumer debt is at record levels. If/when interest rates start up again, there could be a problem

- If foreigners panic and stop wanting to fund our excesses at the rate of $2 billion/day and rising, there could be a dollar panic and higher interest rates, which would dampen our party

In spite of these potential problems, the federal government's completely irresponsible attitude toward long term debt is unlikely to provoke short term problems (barring a foreign creditor panic). Rather, the massive stimulus is likely to win out at the cost of a very unpleasant hangover down the road when we try to retrench. And it will be more unpleasant the longer we put off dealing with it.

     I am a contributor to Americablog, where you can find opinion and commentary on current events, politics and economics

Link to Powerpoint presentation for January presentation of 2017 predictions

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Link to Outline of December 2014 Outlook Speech

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Link to My December 2005 Speech on the Outlook for the Economy

Link to Outline of My December 2004 Speech on the Outlook for the Economy

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