Over the next couple weeks I will be travelling to many of Indiana's cities to explain my 2014 economic forecast.  I thought this week’s column might be a good place to explain the why and how of economic forecasts, along with a sneak peek at next year’s predictions.

A forecast is designed to provide the best possible prediction of economic activity in the future.  Short-run forecasts are designed to predict the ups and downs of the economy, while long-run forecasts predict trends.

Economic predictions are designed to help policymakers craft budgets or program expenditures and businesses make investment decisions or plan inventory levels.  Forecasts cannot be perfect, but even a poor forecast offers a good point from which to start budget negotiations or business planning.

Forecasts are very utilitarian affairs, with a short shelf life. A typical economic forecast is performed by solving a mathematical model. These models depict relationships between different types of economic decisions.  Like most forecasts, the models I use consist of almost 300 equations, and like others, I use several decades of historical data to make these forecasts.

The two most difficult forecasting issues involve identifying and timing the burst of a financial or asset bubble, and the inclusion of future policy changes.  Right now, dozens of graduate students are likely working hard on better bubble predictors, so we should get better tools in the coming years.  As it appears right now, it is the effect of new policy, not financial bubbles, that will dominate the economic landscape of 2014.

Over the coming weeks I will be telling audiences that the national economy will perform poorly, and that we will not return to pre-recession employment numbers this year.  One reason for this is that labor markets are seemingly disengaged a bit from the production of goods and services.  Quite simply, the overall economy has recovered, but employment has not.  There may be several causes for this, such as a skills gap, rapid productivity growth and even continued low demand in some places.  However, the most persuasive argument is that the many changes to government programs that accompanied the stimulus have so dis-incentivized work as to keep millions of workers at home. 

I will also report that the healthcare sector is currently shrinking, and will continue to do so for the remainder of 2014.  This is wholly due to the uncertainty (and in some cases unpleasant certainty) of the Affordable Care Act.  The shrinking of the healthcare sector in 2014 might strike some as evidence that health care costs are being contained at last.  It isn’t, and one need only ask anyone who has just received a new insurance premium rate to confirm there’ve been no cuts. 

The ACA not only affects the healthcare sector, but also employers of more than half of all Americans literally have no idea how much their health-related labor costs will be next year.  That will slow hiring, dampen investment and weaken consumer sentiment. Overall, 2014 will be another dismal year for the nation’s economy.