Good Economic News & Bad Economic Models

Good Economic News & Bad Economic Models

After what may be the last big snow of this winter, downtown Chicago is sunny and the streets around the Sears Tower and Nadex's building, 311 South Wacker, are glossy with melting slush. It seems to reflect the economic news out today.  



Good Economic News & Bad Economic Models
Good Economic News & Bad Economic Models

As the US emerges from winter and the freeze it put on the economy, a couple of reports today, the Consumer Price Index and New Home Sales, were not just surprising, like blue skies after a snowstorm, but remarkable. 

So it may be no surprise that some economists are having trouble fitting lower unemployment, price growth, and a huge jump in home buying into their conceptual models. But first, the good news. 

This morning the CPI showed a 0.2% increase, matching the estimates of 88 economists surveyed by Bloomberg and, if you take out food and fuel, exceeding them. Higher prices, when there is stable supply, means increased demand. Increased demand means people not only want to buy things, they are willing and able to pay more to get them. 0.2% more. Desire and the means to fulfill it drive economic growth. 

Apparently one of those desires is a new home. The Commerce Dept. reported that new home sales totaled 539,000 in February, an increase of 7.8%. The median prediction among economists was a slight drop from January. The number (which may be revised) exceeded even the most optimistic predictions. 

One reason for predicting a drop was simple: February was cold and snowy, not ideal for home shopping. It was not ideal for anything but online shopping. Other figures had suggested that real estate had been hurt by the weather in February. 

Home sales, especially new home sales, are an interesting barometer because they show people's expectations about future incomes and plans. Families aren't just buying a thing, they're making plans for their lives and where they will center them in years to come. Their kids may be born and grow up there, they may grow old there. They will make memories. Buying a home is a statement of desire, many desires, and the confidence you will have the means to fulfill them. 

The reason so many more people have that means now is that they have jobs. The third number to keep in mind, along with gently rising inflation and surprisingly jumping home sales is the relentless 60 straight months of job growth. Economists create models to show the relationships between such numbers, which is why the recent statement by David Mericle, a Goldman Sachs economist, is puzzling. 

Mericle believes that job growth has been been "running 'too hot' recently" and has to slow down to fit with overall economic growth. It's a perfectly sound argument if you believe that jobs are an expense and not an engine. I'm sure Mr. Mericle doesn't mean to say we have too many employed people, but it's funny how an economic argument can take you there.

In fact, jobs are an engine. People without them don't buy things. Which means people who make and do things have no work to do, so they don't buy things, either. Many economists work with models that, whether by chance or intent, see people as more cost than benefit.

That's why economic models are often based on a "rational actor" who always makes logical decisions. The rational actor is not human; he's tidy in his ways. He's easier to write equations about, but he's not us. Most economists' models ignore the logic that lives in our most human qualities, like hope and yes, love. This is why the new branch of behavioral economics is so compelling. 

Not having such emotions would make life worthless. So having them is, well, logical. Until our economic theory can accept the logic of such irrational things as the desire to have a happy home, paid for by a fair income from a good job, and not financed by a subprime mortgage, the theory will be flawed and get surprised by things like people braving the winter cold to go buy a new home. 

In Hemingway's A Moveable Feast, he writes about coming in from a cold evening in Paris to a warm cafe and, over a meal of oysters and white wine, warming up and thinking thoughts he hadn't allowed himself in a while. "I began to be happy," Hemingway writes, "and to make plans."

One cold day when I was in Paris teaching a writing course, I went to what may be the same cafe, had the same meal, and felt the same optimism. It wasn't cheap, but the waiters found me a corner seat and let me sit with my notebook for hours. In other words, I wanted something and I was willing to pay a little more for it. Perhaps my personal CPI had increased. And perhaps after a long, cold winter, Americans are beginning to be happy and to make plans. 


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