Uncertainties of Economics Fog Already Cloudy Forecasts / 'One Thing Is Certain: A Contraction Will Come - Most Probably by Surprise'

Article excerpt

President Truman longed for a one-armed economist who would not keep saying ``on the one hand ... on the other hand.''

So do virtually all other decision-makers in government and business. But, as strong as the desire for unambiguous and unconditional forecasts may be, the real world is one of uncertainty and contingency, as shown by Kenneth Arrow, the Nobel Prize-winning economist of Stanford University.

Horace W. Brock, president of Strategic Economic Decisions Inc. of Menlo Park, Calif., and a former student of Professor Arrow's, maintains that the inability to make exact forecasts ``should no more indict economics than physics should be indicted for the inability of physicists to predict the path of a scrap of paper falling from a desktop.''

What it does imply, he believes, is that economists should build uncertainty into their models and use their own and other people's subjective judgment to make forecasts that at least tell decision-makers what the odds are on any outcome.

These days, with the bull market in stocks and the expansion of the American economy more than five years old, the question worrying investors, business executives and others is: Will there be another crash? Ravi Batra's book ``The Crash of 1990'' is climbing on the best-seller list.

Brock breaks down the future like this: What will trigger the next recession? How bad will it be? How will the government respond? And what will happen to interest rates, the dollar and stocks?

His Strategic Economic Decisions group does not think a U.S. recession is likely within the next year; it says the probability of a recession before 1990 is 45 percent - less than even money.

But it says: ``One thing is certain: A contraction will come - most probably by surprise.'' When it does, the financial markets will be turbulent, and the careers of investment managers and traders will depend on whether they draw right or wrong inferences about the future.

As things look now, three events could start a recession:

- A credit crunch (in which a tightening of credit by the Federal Reserve forces businesses and banks to cut their investments).

- A financial crisis (which could result from a third-world debt crisis, a collapse of the ``junk bond'' market, bank failures amid farm, energy and real estate problems, a collapse of Japanese stocks or a nose dive of the dollar).

- An ``autonomous'' contraction of the economy (stemming from an exhaustion of consumer spending, with real income stagnating and consumers overburdened with debt).

How severe will the recession be when it comes? The probabilities range from very severe to moderate. …