Models: In a Funk
PETER G. HALL
and Chief Economist
market volatility gives economic models a headache, then they have a
whopping migraine at the moment. Critically dependent on past trends,
models are now having to absorb the mega-changes of the last growth
cycle, and so far, their record is sketchy. What are these model-rocking
Technology grew exponentially in the last cycle, revolutionizing
business processes and setting in motion the equally exponential
explosion of globalized trade and investment. This has lifted nations
that were isolated into the mainstream, shifting economic power and
stoking demand for resources.
Growth was extended. The last growth cycle was a marvel. Lasting
16 years, it was twice the length of a normal cycle, convincing many
that we had achieved a recession-proof ‘new normal’.
Excesses were enormous. The protracted growth cycle created
wealth and spurred confidence enough to get Western consumers spending
well beyond their means en masse, a frenzy that characterized the final
five years of the cycle. Businesses invested to keep pace with this
excessive consumption, and in a globalizing world, these excesses were
exported – everywhere.
Recession revealed the extent of these excesses. This was no
ordinary correction, but the biggest disruption to economic activity in
over 60 years. Regular recessions are frightening enough, but this one
caused confidence to implode. What fed the ensuing panic was the very
length of the growth cycle itself. Over this period many entered the
labour force with little, if any, experience of ‘down’ – and
therefore few tools or mechanisms for coping with or strategizing around
The response? Public stimulus, on a scale never before seen.
Bereft of private-sector solutions, we collectively turned to our
governments, and they did not disappoint. Together they fashioned a
swift, significant and synchronized package of spending, taxation and
interest rate measures that had a marked effect on global growth in the
six months following the summer of 2009. The measures were so effective
that many believed they had kicked off the new growth cycle. But they
The current change may well be the most challenging. The effects of
stimulus wore off before the colossal excesses were fully absorbed,
ushering us into a perplexing phase: the flat zone. We
have been here for about a year now, and will be for a few more months
until demand and supply conditions become more balanced. It’s a
difficult phase because we are naturally wired for growth; flat
performance feeds uncertainty, and has created an appetite for
high-frequency indications of an economic turn for the better.
Overreactions have produced the unusual volatility we now see.
These changes will continue to have an influence on the near-term
outlook. Models will be challenged by a key feature of the future: the
extended withdrawal of fiscal and monetary stimulus, and its effects on
real economic activity. Many wonder if we will ever get back to what we
used to consider normal.
The bottom line? Economic models are not broken; they are just having a
hard time adjusting to new economic realities. In time, the models will
be recalibrated, soothing the headache. By then, we will be back to the
business of growth, where model misfires matter less.
views expressed here are those of the author, and not necessarily of
Export Development Canada.