Before reading on, why not ask yourself this question: what do you expect next quarter's GDP growth figures to be? How about the next 12 months? And why? I'd be interested to see some of your answers in the comments to this post - please also say which particular GDP figures you're predicting (personally I'm most familiar with the UK and US figures, but would be interested in comments from the eurozone and other regions too)*.
I'm not going to test you on the accuracy of your forecasts: I'm more interested in the prediction itself, and your reasoning, than whether it turns out to be right.
My prompts for thinking about this are:
- a paper Roger Farmer sent me this evening, introducing the concept of a belief function describing what people expect next year's growth and inflation figures to be
- David Smith's blog excerpt of his Sunday Times column today, in which he discusses this quarter's UK GDP figures, and the differing unemployment picture between the UK and the US
- (Honourable mention also to Scott Sumner's post on British austerity, which is more about the balance between monetary and fiscal policy but is also implicitly about the effect of growth expectations on current growth.)
- This quarter's GDP growth?
- Your personal experience of the economic environment? (Chris Olivola mentioned some research to me the other day: if you ask people whether they believe in global warming, they are more likely to say yes on a hot day than on a cold day. He said this is like asking someone how the economy is doing, and they answer based on how much change they have in their pocket).
- What you read in the media, or hear from your friends, about GDP growth?
My hypothesis: point 3 has the biggest impact. I don't think most people in business know the current GDP figures. And I think our direct experience of economic events is strongly filtered through the lens of our beliefs; which are in turn influenced by the information we receive from outside. If the media, and our friends, think there is still a recession, then we will expect growth to be slow. And this, to some extent, will mean that growth really is slow.
Of course expectations are only one factor that influences GDP - inventories, replacement cycles of durable goods, fiscal policy, wealth and incomes, exports, and exogenous events such as weather or the Olympics are all important too. The balance of these different factors is one of the main research subjects of empirical macroeconomics. But the effect of expectations, especially on investment but also on employment, is strong.
Thus, we want to understand how people form their opinions about future growth. How much of their beliefs do they gain from media messages? How much from social contact? (And how much from direct evidence gathering?) How were those media and social messages formulated? How did those journalists or friends pick up their beliefs in turn? What is the lag time? How fast do beliefs spread, and what are the conditions that influence that velocity?
These are critical research areas for cognitive economics. I don't know of any programme of research across these areas, so maybe I need to start one.
* I'll post my own predictions tomorrow