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Explaining
the Economy

Leroy Laney

Sunday, November 11, 2001


Economic forecasting
has its limits, particularly
without any history to rely on

The events of Sept. 11 are having economic impacts throughout the world. We already know Hawaii will be among the most affected areas, if only because we are so enormously dependent on air transportation.

The mere inconvenience of added security measures often is causing travelers to choose other modes of travel. Those modes will get a tourist to a mainland destination, but there is no alternative to air travel in reaching our island state.

In the post-9/11 environment, Hawaii's economy must guard against turning inward, a status anathema to today's globally interactive world. Cutting off or even reducing contacts of any kind with the rest of the world would necessitate a big contraction in our economic activity. At the very least, times like these force us to realize and confront the harshest reality of our isolated island economy.

There have been other episodes when Hawaii has been forced to confront its vulnerability to global uncertainties. The Gulf War in 1990-91 caused a big drop in tourism. That episode is often cited as a benchmark for the beginning of the worst decade on record for Hawaii's state economy. Yet the Gulf War had a finite objective and conclusion. Those things do not seem to be in the offing now. The economic and social uncertainties now are almost an order of magnitude greater.

Even greater downside risks than these obvious ones may include:

>> The Federal Reserve has and will continue to deliver lower short-term interest rates, as needed. But the central bank has much less control over long-term rates. Fears of a vanishing budget surplus and a return to deficits may increase long rates. This can dampen investment, here and elsewhere.

>> If conflict in the Afghanistan arena spills over into neighboring oil-producing nations, or if those countries simply become involved in some way, oil prices can rise and become more volatile. Hawaii felt the effects of oil price volatility during the Gulf War. Despite the presence of alternative energy sources, we remain more dependent on fossil fuels than other U.S. states.

Other local economic forecasters already have been forced to revisit pre-9/11 projections and to give explicit numbers on what 2002 now holds in store. I shall present my own numbers Friday at First Hawaiian Bank's 32nd annual Business Outlook Forum.

Economic forecasting aims at a moving target even in normal times. In the current situation, quantitative projections are particularly difficult -- especially to predict the trajectory of the downturn and recovery. The more time elapses, the more we will come to know. For example, we are encouraged to see signs of recovery in the domestic tourism market, even if Japan has shown none. Still, it takes little imagination to realize that the world can change drastically again, just as suddenly as it did on Sept. 11.

Given the unprecedented uncertainties -- both economic and non-economic -- near-term projections on precise point estimates of growth is particularly risky. I believe strongly, as Fed Chairman Alan Greenspan stated, sometimes it is "better to be right than to be quick."

Some people may think economists hear voices in the air that tell them how these numbers will behave in the future. The real process is a little more prosaic. Most forecasting exercises fit historical data to time series models, which estimate coefficients that can be extrapolated to the future. But when historical data contains no precedent -- and there is no precedent for the situation in which Hawaii now finds itself -- this methodology hits more than a few potholes. You will hear a number of economic projections in coming months, and revisions and more revisions. Bear in mind their very tenuous nature in the current environment.



Leroy Laney is a professor of economics at
Hawaii Pacific University. Reach him at
lo9_laney@hotmail.com.


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