Economic Forecasting and the Goldberg Variations

As anybody who has tinkered with building even a rudimentary version of a Goldberg machine knows, getting to the point where the perch actually tips would be a minor miracle. But year-ahead forecasts often look a bit like Goldberg machines—and when it comes to 2022, the forecasts might be even more complex.

For example: Perhaps Covid-19 worries will ease enough that (A) global supply-chain problems are ironed out, (B) leading to an increased availability of goods, (C) a shifting of consumer demand toward services, (D) and greater labor availability, (E) all of which ease inflationary pressures, (F) allowing the Federal Reserve to raise rates only marginally (G) while the economy strengthens (H) and stocks rally (I).  It is a plausible-seeming scenario—one that, if it came true, people might say, “Of course, that’s how it worked out.”

But with so many steps, so many things could go wrong.

A bad Omicron outcome, or yet another worrisome coronavirus variant, could worsen bottlenecks. Older people who left the workforce might not return, leaving labor tight. And so on.

Other scenarios also seem Goldberg-esque, such as one where persistent bottlenecks (A) leave inflation elevated, (B) ratcheting consumer inflation expectations higher, (C) which, in combination with a continued tight labor market, (D) leads to inflation-adjusted wages rising significantly faster than productivity, (E) and companies pushing through price increases (F) to offset rising labor costs.

For a look at how poorly forecasts can turn out during the uncertainty of a pandemic, one need only look at what people said 2021 would look like. Federal Reserve policy makers, for example, projected that the unemployment rate would average 5% in the fourth quarter and that their preferred measure of inflation would be up by 1.8% in the fourth quarter from a year earlier. It turns out that the unemployment rate is nearing 4%, and inflation is over 5%. Private economists’ forecasts were, if anything, even further off.

So the odds of the Fed’s latest projections—showing that unemployment will average 3.5% in the fourth quarter of 2021 and inflation will slip to 2.6%—coming true might not be so hot. The Fed has acknowledged as much. Indexes of forecast uncertainty created by the central bank show policy makers are highly doubtful of their own estimates.

The point here isn’t just to poke fun at year-ahead forecasts, but to recognize that while it is useful to think about what things might look like in a year, it is more important to have a good idea of what is happening now and what could happen next—especially considering how much uncertainty the pandemic has created.

At the moment, the economy is growing strongly; strained supply chains and heavy demand for goods are pushing prices higher; the labor market is tight and Covid-19 cases are rising rapidly.

Some important questions to ask are the degree to which goods demand might be sated; whether recent indications that supply chains are easing portend a shift; how much reduced government support for households might pull people back into the labor force; how much Covid concerns might keep them away and, finally, what Omicron will look like over the course of the winter.

Policy makers, investors, businesses and ordinary Americans who can come up with reasonable estimates for what the next few months might look like could be much better prepared for 2022 than those who try to guess what might happen over the entire 365 days.

Write to Justin Lahart at justin.lahart@wsj.com