Friday, July 8, 2011

‘Animal spirits’ update

Recall that the primary driver of confidence levels of Americans, in my view, is whether the unemployment rate is above or below an exponential moving average of where it’s been over the past four years. Obviously, it’s been above what we’re used to for a while, which is depressing. The blue line is a forecast, indicating that we might enjoy a transient, weak secular exhilaration in mid-2012. Notice how the unemployment rate shoots up after it crosses from below to above the adaption level, as people lose confidence quickly and a self-organized criticality overtakes the labor market.


This is our “animal spirits” metric: A = – (U – UMEAN)/Sigma(U), shown below.


Symmetrically, a great coincident indicator of the onset of a recession is the A metric falling below zero. Confidence collapses as people start discounting losses instead of gains. Currently, A is trying to rise above zero, as it would have done long ago in a normal expansion, but has failed to do in this jobless “recovery.” Note that the green line, the Michigan Consumer Sentiment series, is lagging in this cycle, as folks look beyond the headline unemployment rate to the truly sick state of the labor market (cf. CR’s graphs).

Here is my judgmental forecast of the unemployment rate up close:


If the unemployment rate manages to dip below 8.9 percent in 2012 there will be the slightest of technical reasons for “animal spirits” to revive. The run-up to a Presidential election year tends to be euphoria-inducing, no matter which side one is rooting for. But any movement toward fiscal tightening, which seems inevitable, will quickly deflate aggregate demand and send unemployment higher, and “animal spirits” back into the hopper. The resulting slump would be the 2010 decade’s analogue to the 1938 slump during the Great Depression, which was an almost 20 percent decline in Personal Income from peak to trough.

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