Forecasting the economic future

Date posted: December 20, 2010

Everyone wants to have a crystal ball regarding the economy, but few of us have one. Economists are often asked to peer into the economic future. N.C. State University economist Mike Walden explains the techniques that economists use to do that.

“There are several. One is to develop an economic model that mimics the economy. It is not going to be as complicated as the economy, but it is supposed to mimic the main movements of the economy and then to use that model to forecast where the economy is going. The problem with that is you have to forecast the key inputs that drive the economy. So forecasts are forecasting forecasts if you will.

“Another simply is to use the stock markets. The stock market has a pretty good track record of leading the economy — when it goes up, the economy grows; when the stock market goes down, oftentimes the economy falls.

“A third technique is a little technical. It is to compare the difference between long-term interest rates and short-term interest rates. Usually log rates are higher than short rates, but if it becomes reversed — that is, short rates are higher — usually that is a good sign of an upcoming recession.

“And lastly is to focus on some individual indicators. These are measures that typically lead the economy, like first-time unemployment claims, building permits, and manufacturing activity.

“The bottom line is if you use all of these techniques, the good news [is} they have all improved since mid-2009, indicating the economy at least is moving in the right direction.”

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