Here’s another thing the pandemic has messed up: economic forecasts

Ian Shepherdson knew he was sticking his neck out. But recently he released a startling forecast: the government’s next labor market report would show that the US economy added 850,000 jobs in December.

Less than 24 hours later, it became clear that Shepherdson, the chief economist and founder of Pantheon Macroeconomics, had missed the mark and badly missed it. In the last month of the year, employers had actually hired just 199,000 workers, less than a quarter of the number it had forecast, according to the government’s closely watched monthly tally.

For Shepherdson – and many others on Wall Street – the jobs forecast was both an absolute flop and an illustration of how difficult the pandemic is making it difficult for even the most astute observers to assess the economy. of 23 trillion dollars.

“Everyone wants to pursue precision,” he said in an interview. “But even before COVID, it was like hitting a moving target from a moving vehicle. Now we also have a blindfold.

The pandemic is making hard work even harder. As the virus waxed and waned, it caused some of the craziest ups and downs in US labor market history. The recession and COVID recovery have also erased economic relationships, emptying downtown office districts, sending workers toiling in their living rooms and leaving economists fumbling.

This has resulted in an economy perched uncomfortably between the world of early 2020 and the reality that will emerge once the pandemic is a memory. Meanwhile, the familiar relationships between key economic variables have gone haywire.

Although wages are rising faster than at any time in the decade before the pandemic, for example, the number of Americans reentering the workforce has been disappointing. Two years after COVID-19 first hit the United States, the labor force participation rate remains near its lowest level since the 1970s, when women began entering the labor market lots of work.

Yet a different measure, which tracks the number of employed Americans aged 25 to 54, relative to the total population, last year showed the fastest year-on-year gain since the government began tracking in 1949.

“This is a historically unique American economy,” tweeted economist Skanda Amarnath, executive director of Employment America, a nonprofit that promotes tight labor markets.

Monthly job gains were also exceptionally volatile. During the last half of 2019, monthly hires fluctuated between 161,000 and 234,000 people. The last six months of 2021 saw fluctuations between 199,000 and 1.1 million.

All of this uproar has left economists in government and the private sector struggling to figure out what businesses, workers and consumers will do next.

“It’s extremely difficult to make forecasts in the current environment,” said Gregory Daco, chief US economist for Oxford Economics. “It requires a strong dose of humility. We are more likely to be wrong, given how quickly things are changing.

Even if economists are well trained to calculate future levels of hiring, investment, or trade, they are no better qualified than anyone to predict the next move of a shape-shifting virus or hyper-polarized capital.

Yet after more than three decades of tracking major economies, Shepherdson is no novice. He is twice winner, in 2014 and 2003, of the Wall Street Journal award for best economic forecaster.

He was not the only one to have missed the call for applications in December either. The consensus of professional economists predicted more than twice as many jobs as there actually were. Moody’s Mark Zandi expected 750,000 while Goldman Sachs analysts expected 500,000.

Ideally, economists make predictions by comparing current conditions to a previous period when the underlying structure of the economy was similar, said economist Michael Strain of the American Enterprise Institute. But there is no precedent.

“The problem is, what possible period do we have when the economy is close to where it is today?” said Strain, a former Federal Reserve system economist. “Some people just use the same models they used and it doesn’t work.”

Shepherdson is not one of them. He says he realized that the pandemic had made traditional models “more or less useless”.

So it revised its formula to account for the transformation of the economy, relying more on high-frequency data from HomeBase, a provider of scheduling and payroll software for small businesses.

HomeBase data has been praised by Federal Reserve officials for its usefulness in anticipating labor market movements. But the firm has only produced its monthly reports since the start of the pandemic. Relying on a shorter data series inevitably means a larger margin of error, Shepherdson said.

“Until we have five years of this HomeBase data, we won’t really know how useful it is,” he said.

Forecasters today face a dual challenge: uncertainty about where the United States stands in the business cycle and what the post-pandemic economy will look like, according to Erica Groshen, senior economics adviser at the School of Industrial and Labor Relations from Cornell University.

Adjustments that government economists use to compensate for routine seasonal fluctuations, including the big cycle of hiring and laying off retailers during the holiday season, are also failing amid the pandemic.

“Models predict what is normal in a world that is not normal,” said Groshen, former head of the Bureau of Labor Statistics.

This is not the first time models have failed. In 2008, many Wall Street firms were stunned when the real estate implosion caused huge losses in mortgage-backed securities. Big banks’ “value-at-risk” models, based on years of housing market data, had predicted no drop in nationwide house prices.

Since previous downturns had been limited to specific regions, Wall Street’s supposed best and brightest future declines would also be limited. When they weren’t, a wave of seizures resulted in massive losses. Venerable companies such as Bear Stearns, Lehman Brothers and Merrill Lynch have gone bankrupt or been swallowed up by rivals. The net worth of American households has fallen by more than $11 trillion.

“This whole market depended on finely tuned computer models – which turned out to be out of touch with reality,” concluded the 2011 report from the Financial Crisis Inquiry Commission.

Wall Street’s reliance on the past to predict the future has limits. But if the pandemic has thrown traditional economic relationships so unbalanced and undermined the quality of key inputs, some wonder what the point of publishing forecasts is.

“I personally think all of this forecasting is just marketing for the company,” said Barry Ritholtz, whose New York-based investment firm manages more than $1.5 billion in assets. “The least valuable part of the forecast is the actual number. It is the process that brings something to the table.

The prediction game won’t be getting easier anytime soon. The omicron variant may skew the Department of Labor’s estimate for January hiring.

Meanwhile, Shepherdson took the setback in high spirits. He posted a self-deprecating Twitter thread, which included a photo of an old-fashioned cocktail party tagged “there’s only one answer.”

It was only “the start of the evening”, he said.

“It was a very upsetting day.”

About Dianne Stinson

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