Forecasts lose shine as credit crunch fuels doubt

Forecasters are busy churning out new and gloomier economic predictions because of a global credit crunch whose outcome nobody can be sure of until financial conditions normalise and uncertainty subsides.
Investment bank Goldman Sachs joined the swelling ranks of gloom converts this week, slashing its forecasts for growth in the United States, Japan and Europe. "Much has changed since mid-July, when we wrote that 'the global economy continues to enjoy one of the strongest sustained expansions in modern history'," chief economist Jim O'Neill said in a note announcing hefty forecast cuts.
"The key question, which will take time to answer, is the extent to which the credit crunch will affect the real economy." The IMF is working on new and probably lower forecasts after raising its predictions for much of the planet's growth outlook on July 25, a couple of weeks before central banks were forced to take action to try to head off a full-scale credit crunch.
What none of the old forecasts or the new predictions that are coming out now do is factor in the impact of a crisis that has yet to run its course. Nick Bloom, an economist at Stanford University, has taken a stab at one major facet of the problem, the indirect toll which crises have on business investment, hiring and output because of a sudden rise in uncertainty.
Essentially, this "second moment shock" as he calls it, will have a potentially far greater impact than the crunch itself in the first three to six months of the affair. He constructed a model using stock market volatility during more than 40 years since the Cuban missile crisis of late 1962 as a proxy for uncertainty to help identify the impact that the events have on corporate behaviour.
"These shocks appear to have real, large effects, with the uncertainty component alone generating a one percent drop and rebound in employment and output over the following six months, with a milder long-run overshoot," Bloom says.
The impact of the underlying shock which in the first place triggered the uncertainty at corporate level - be it war, oil price spikes, stock market crashes or the currency credit crunch - can have an impact for a more prolonged period.