The ABCs of forecasting the economy

John W. Schoen Senior producer • Profile • E-mail

Where is the U.S. economy headed? Is the current downturn going to follow a V-shape — or maybe a U? Economists have come up with an alphabet soup of forecasts lately. We'll take a look at theirs and offer up one of our own.

When do you see the economy getting better?
— Betty, address withheld

We used to rely on our Answer Desk crystal ball for help with economic questions like this one. But no matter how much data we fed it, we couldn’t get a straight answer. So we traded it in for a flat-screen TV. Now we can watch economic forecasters come up with creative new ways to dodge the question.

Lately, they’ve been reverting to what we’ll call the ABCs of economic forecasting, assigning letters of the alphabet to their predictions.

For awhile, a lot of them were calling for a “V-shaped” recovery. This scenario calls for a sharp drop down (the left side of the V) followed by a quick recovery. The hope was that the faster the housing and credit markets hit bottom, the sooner everyone could start rebuilding.

But following the collapse of the credit markets last summer and the resulting gyrations in the financial markets, things seemed to be just muddling along. Since we didn’t get a sharp drop, the thinking went, a rapid recovery was unlikely. That got us to the “U-shaped” recovery — a more gradual slide down followed by a gradual climb back up. (A lot of the V-shaped crowd started using this one.)

More recently, we started hearing about a “W-shaped” recovery. According to this analysis, the economy turned down in late 2007 and early 2008 and we’re just now beginning to come back up to the mid-W peak, thanks to the Federal Reserve’s aggressive interest rate cuts and the flood of tax rebates now hitting the economy. Alas, this letter-based forecast suggests those measures won’t have a lasting impact. Once they wear off, the thinking goes, we're going slide down the right side of the mid-W peak before things get better again, perhaps next year.

Lately, we’ve heard another letter invoked: the dreaded “L-shaped” economy. This forecast says the economy slides along at pretty much zero growth — and stays there until mid-2009 or beyond.

If so, we’re hoping that “L” runs into a “J” sooner rather than later and gets us back on track for higher growth and lower inflation. Still, it’s hard to see how that happens as long as employment and house prices are falling and energy prices and home foreclosures are rising. The threat of ever-higher inflation could force the Fed’s hand and drive interest rates back up again — just when the economy needs the tailwind of a continued policy of cheap money.

A lot depends on how soon our government gets serious about tackling some serious economic issues. Start with a sane energy policy, maybe one that encouraged conservation and development of new sources of power instead of just helping oil companies pump more crude. (To start, you could cut the huge corn ethanol subsidies that are forcing up food prices and feeding inflation. There are other, better ways to brew the stuff.)

It also wouldn’t hurt to get serious about cleaning up the mortgage mess. With millions of homeowners stuck in ruinous mortgages facing sky-high payment resets, why not let them convert those exploding loans to fixed, market-rate mortgages they can afford?

So far, the lending industry’s voluntary “workouts” just aren’t cutting it. And if someone doesn’t defuse the alternative minimum tax bomb this year, another 20 million or so American families are going to have to figure out how to come up with tens of billions of dollars in taxes they didn’t owe last year.

Unfortunately, with the election now getting into full swing, Congress and the White House seem to be gripped with a quadrennial case of kick-the-can-down-the-road politics. Unless and until government can get its act together, The Answer Desk is calling for an “O” shaped recovery — with Washington going round and round in circles and the economy going nowhere.

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