Tuesday, April 18, 2023

Economics and the Mona Lisa Smile.

"Mona Lisa."
Leonardo da Vinci.

The Economist this morning observes that economic forecasting has become increasingly unpredictable, with analysts struggling to accurately forecast many key international measures. Contributing to the confusion are challenges in data collection and interpretation due to Covid-19 disruptions and declining response rates to official surveys. The pandemic caused significant fluctuations in growth, complicating seasonal adjustments in economic numbers. Also, reduced response rates to surveys may have led to increased data volatility and potential bias, as non-respondents tend to be less prosperous, which could distort income statistics. The article uses the ambiguous "smile" of Mona Lisa, painted by Leonardo da Vinci via the sfumato technique, as a metaphor for the difficulty of discerning the true state of the economic environment given this unpredictable data. 

One source of confusion arises from the discrepancy between "hard" and "soft" data—objective indicators such as unemployment rates, and subjective variables like individuals' future expectations. Typically, these two classifications of data are congruent. However, at present, they exhibit a stark contrast. "Soft" measures indicate a recessionary trend, while "hard" measures suggest a reasonable economic expansion. This divergence may be attributed to the public's discontent with inflation. In affluent nations, prices continue to escalate at an annual rate of 9%.

Economic measures really matter for government budgeting, as California's Legislative Analyst's office (LAO) relies upon that data in planning future budgets. Necessarily, many of the points the Economist makes about uncertainty get resolved by the LAO in the "negative" (that is, they accept the more dire forecast). As the LAO (accurately) writes in their 23-24 budget analysis, the U.S. economy experienced rapid expansion from summer 2020 through 2021 due to pandemic-related federal stimulus. However, this growth was (as far as the LAO is concerned, and many others) unsustainable, leading to record low unemployment and supply chain challenges, causing consumer prices to rise 8% year-on-year. To combat inflation, the LAO points out that the Federal Reserve has enacted large interest rate increases throughout 2022. The LAO interprets the hard data it sees, that California is experiencing decreased home and car sales and falling stock prices, as well as weaker state tax collections, and concludes there is a slowdown in the economy. 

The LAO, though, is looking at some of the same data as the writers of the Economist, and thus notes that while overly optimistic projections could result in future shortfalls, an excessively pessimistic projection could lead to premature cuts to public services. Further, despite all the foregoing, the LAO points out that "the state can afford to maintain its existing school and community college programs and provide a cost-of-living adjustment of up to 8.38 percent in 2023-24," which would essentially meet the rate of inflation for educational funding in California. Despite the economy's sfumato, at least that is clear.