Monday, August 6, 2012

When will confidence (‘animal spirits’) collapse?

The theory of confidence that I adhere to says that it is the relationship between the U-3 unemployment rate and its exponential moving average over the past several years that determines the level of confidence (for many practical purposes, such as the timing of recessions):

A = – (U – UMEAN)/Stdev(U) .

Shown below are recent actual values of unemployment and the adaptation level and my judgmental forecast:


I continue to believe that confidence will collapse in mid-2013.  Whether the “recession” is declared to begin then or now or somewhere in between is up to the NBER in its ex poste facto wisdom.

Here is what “animal spirits” look like according to the forecast:


Green is the Michigan consumer sentiment series.  If the BLS manages to keep reported U-3 unemployment below about 8.8 percent until the election, confidence will remain “positive,”  and, other things equal, the President has some chance of reelection. If unemployment rises above 8.8 percent in the next year, confidence will collapse.

The situation continues to resemble 1972-1973 in the relative configurations of the Michigan measure (depressed but trying to rise) and the A metric (positive, but poised to fall).  By all accounts the current cyclical expansion is the weakest in the postwar period, so a short-lived and fey recovery is to be expected.


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