AlSimonov
What should the policymakers do in an economy like the one we are now in?
The recent efforts seem to be that the policymakers set up a picture for the future, the future that they want to achieve…and then work their policy tools to achieve that future.
What if that doesn’t work?
What if the models that the policymakers work with aren’t useful?
What if the policymakers don’t have a good feel for the economy?
These are major questions today.
Jeanna Smialek writes about this in the New York Times.
“Trust the Models? In This Economy?”
“Years into the pandemic, it is still difficult to get a handle on what comes next for the economy by looking at examples from the past.”
“Forecasts have been upended repeatedly.”
“Now after a year in which the Federal Reserve raised interest rates at the fastest pace since the 1980s to slow growth and bring those rapid price increases back under control, central bankers, Wall Street economists and Biden administration officials are all trying to guess what might lie ahead for the economy in 2023.”
The emphasis here should be placed on the word “guess.”
We are all guessing right now.
We don’t really know what all the possible outcomes might be. They are impossible to describe. Statisticians will tell us that our historical data are next to useless because the economy is so unstable that the usual relationships just don’t seem to hold anymore.
We are in a world of radical uncertainty.
All the old data contribute little or nothing to the future forecasts.
We must work off of narratives, which means that we cannot forecast with any exactness. We can only draw pictures and track what works.
This gets us into the environment of those economists and others that believe in the policy approach of “nudges.”
That is, we don’t paint the picture of the future and then create the policy that might get us there.
Instead, we decide the direction we want to move in, and then nudge the policy variables in the desired direction and then see how things work.
If the system seems to move in the direction desired, then more of the policy can be applied.
And, so on, until the policymakers get where they wanted to go.
The Current Situation
Ms. Smialek does a very good job in her article laying out the current situation in specific markets, the housing market, the labor market, and the car market.
She covers the recent history in these sectors and discusses how analysts are having difficulties of working with the current data and coming up with any solid picture of how these markets are going to behave in the future.
Ms. Smialek ends her article with the quote:
“The thing that has never happened would have to happen. But, hey, things that have never happened have been happening left and right.”
That should give you a lot of confidence.
But, there is another thing looming on the horizon…the debt bubble.
This is the bubble that the Federal Reserve enlarged in the 2020-2021 period when it was fighting the spread of the Covid-19 pandemic.
Approximately during this period of time, the Federal Reserve acquired about $4.5 trillion to add to its portfolio. The banking system was flooded with liquidity. Debt multiplied, not only in the public sector, but in the private sector as “players” created more and more useful ways to put the liquidity to work.
We now have a massive amount of debt outstanding in the world that is waiting for the Federal Reserve to tighten up on the monetary system and force a shrinking of the bubble.
One of my readers commented that bubbles don’t usually shrink…they burst!
But, another result of building bubbles that there is no real consistent path to the development of the bubble.
One of the results of the bubble created by the Fed in the 2020-2021 period is the contribution it made to the growth and expansion of the cryptocurrency world. And, on the other side of the bubble, as the Fed began to tighten up on monetary expansion, we get the collapse of organizations in the crypto-world, like FTX, that profited mightily the Fed’s largess.
Now we wait for what it to come next.
Needless to say, we have no idea where other “busts” might occur.
The future of the bubble is “unknown.” Radical uncertainty all over the place.
The Future
So this is where we are going in this uncertain world.
We are going into more and more uncertainty, with some of the uncertainty coming from not knowing exactly what the Federal Reserve is going to do.
This leads me back to the topic I introduced earlier in this article: nudging.
When a policymaker “nudges” a market, he or she is basically admitting that his or her knowledge of the market is limited and, consequently, the policymakers must move with caution to achieve the result wanted.
Policymakers use to move with the “feel of the market.”
This allowed markets to move in the direction that policymakers desired, but did not create greater difficulties along the path by overdoing things or by taking the wrong path.
When you don’t know what the possible outcomes might be, when you cannot use the statistics in the way you used them in the recent past, when the world is disrupted to the extent that we don’t really see how things might work together, or the economy is in such disequilibrium that we don’t know how markets and sectors are going to stabilize and go forward.
This world of radical uncertainty certainly raises questions of the most difficult sort.
That, however, is the world we currently live in.
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