Handwaving on the Economy

Fred Wilson had this recent post on the state of the economy. I dropped a line in the comments section of that post (faithfully reproduced here):

“Making predictions about the economy is an exercise fraught with uncertainty (especially for someone who writes code for a living!). But here goes...

It seems like older economic models that guided conventional wisdom can no longer be relied upon in an increasingly globalized world. For example, the inverted yield curve is no longer reason to proclaim recession (so long as the Chinese continue to subsidize American long term interest rates). The US economy is holding up quite well to the high price of oil which is no longer reason enough to predict stagflation.

Likewise, its hard to say that the current boom in web services will burst even if there is a recession. Why? Because monetization for these companies is primarily ad-driven and they will continue to make money as consumers continue to spend more time online (or using their cell phones and iPods) and advertisers respond to this trend.

The burst of 2000 was not so much about economic cycles as it was about a cycle of greed. The fact that investors this time round are maintaining a laser sharp focus on monetization, makes a burst less likely this time round.

I am not disputing the cyclical nature of the economy. All I am saying is conventional wisdom cannot be used to guide investment decisions.”

While most of what I say here is stuff I still stand by, the last comment about the “cyclical nature of the economy” what I am going to talk about here. While I was sleeping, the community of economists seem to have developed a vigorous culture of blogging and a post I read on Prof. Greg Mankiw’s blog got me thinking about something we take for granted – namely business cycles. I am sure this topic has generated much ink in academic circles. But like most other people who have little more than a dilettante’s interest in economics, I look for simple mental models to explain economic phenomena and rely on articles like this one which speculate on the question of whether “the Fed will go too far.” Even modest changes in the Dow and the Nasdaq that follow the Fed Chairman’s speeches are interpreted by the mainstream press as “signs” of the market reading the FOMC’s mind. But the answer is, the Fed will always go too far. The Fed’s only job (by congressional mandate) is to maintain price stability. Do you remember the Fed Chairman talking about anything other than the need to contain inflation? I am thinking that the Fed would much rather bring a recession upon us rather than have the inflation dragon rear its head. They will of course do this by making monetary policy less accommodative than it needs to be. But theories about recessions in the mainstream are limited to “bubbles bursting” and “infectious greed”. Hence this rant : )