Most economic theorists who got their doctorate in the subject apply arcane, complex and (to the average citizen) incomprehensible formulae to the study of what is happening, and what will happen in any given economy. One could argue that their hard work, long study and brilliance have been wasted, else they would have predicted the Great Recession sufficiently far in advance to allow all of us to take preventive measures. There were no general alarm bells sounded by the minds charged with minding the proverbial, and literal, store.
In 2000, an article was published by by Prakash Loungani, then assistant to the director, External Relations Department, at the International Monetary Fund. His research showed that of the 60 national recessions occurring in the 1990s, only two were predicted accurately. And even as the recessions grew near, two months prior to their commencement, only a quarter of them were anticipated.
In August of 1990, a couple of months into what would be recognized as a decently serious recession, Alan Greenspan said that “those who argue that we are already in a recession are reasonably certain to be wrong.” I guess if you say it with class, good diction and confident understatement, you must be right. Until you’re wrong, that is.
Some people in positions of authority, like politicians, central bankers and regulators, have even gone so far as to simply ask others who should know what the future portends. The Survey of Professional Forecasters regularly asks respondents to provide separate estimates of the probability that real GDP growth will be in the current quarter and the subsequent four quarters. This survey of paid prognosticators was first created in 1968 as a collaborative effort between the American Statistical Association and the National Bureau of Economic Research. The survey was taken over by the Federal Reserve Bank of Philadelphia in 1990. Let’s see what the Professional Forecasters said about the odds of a recession, in their first quarter report of 2008, published February 12th of that year:
“The forecasters are pegging the probability of a downturn this quarter at 47 percent… The forecasters expect growth of 1.3 percent in the second quarter, marking a downward revision from 2.3 percent previously, and they are assigning a probability of 43 percent to negative growth. The forecasters see growth of 2.8 percent in each quarter of the second half of the year.”
So the probabilities were pretty much the same as flipping a coin to predict the quarter they were already in, and a fairly optimistic 57 percent expectation of positive growth in the second quarter, with a strong second half.
Let’s see what the Professional Forecasters said as of Aug. 12, 2008:
“Growth in U.S. real output over the next few quarters looks slower now than it did just three months ago, according to 47 forecasters surveyed by the Federal Reserve Bank of Philadelphia.”
We all know what happened in the second half of that year, right? So essentially, they couldn’t hit the bullseye three months in advance. Since it often takes months for our economists, regulators and “professional” forecasters to recognize that we’ve been in a recession for some time, one could justifiably suggest that the Professional Forecasters should be fired for phenomenal incompetence.
All of the important and educated dialogue about “leading indicators” has got to be the biggest hoax blanketing our collective consciousness since we were told that highly processed, bleached, nutritionally bereft white bread was good for us, “twelve ways.” If there really were leading indicators that were worth anything, we’d have avoided the economic tsunami that is just now starting to recede, albeit slowly.
Some, like Mr. Loungani, suggest that the problem lies in how the forecasters are paid. Political precognition is driven by the goal to get elected, not to be accurate. Banking economists have two purposes: one, to ensure that their employer takes advantage of information before somebody else does, and two, to ensure that there is a plausible story to tell the customers to keep them buying services from the bank. Academicians are driven to invent unique methods and propose interesting, novel analytics that can form the basis for doctoral theses, publications in peer-reviewed journals and pedigrees that will impress the elite financial service companies who will (they hope) hire them into prestigious, highly paid positions. If you have read Frank Partnoy’s books about Wall Street, you’ll understand just how those academic brains were put to good use inventing such financial clockworks as the “collateralized debt obligations,” whose painstakingly calculated asset values evaporated over the last three years.
There is certainly the conflict of interest that prevents good forecasting. But there is also another matter to contend with. Even if we had good models that could identify the strong correlations associated with boom and bust cycles, there would still be the human tendency to simply not want to look ahead. How many people do you know who do 10-year planning for their own lives, let alone for their employers? Even people who have built businesses have trouble thinking past the next payroll. Humans, for the most part, don’t think about the future so much. They don’t like to. They might start getting interested in history more as they age. That seems to be a common trend. But a tiny fraction of the population puts two and two together to predict a four arriving a few decades hence.
Maybe we’re built that way. Out of the quarter million years that homo sapiens has claimed its current brain pan and abilities, 99 percent of that time has been spent planning out the next year’s seasonal challenges, staying loose to respond when the weather changed unexpectedly or a marauding band of raiders showed up at the gate. We are probably hard-wired around a one-year future perspective and an instinctive talent to react quickly and effectively. A rare few of us can look farther. Boy do we need those rare few now.
Friday, December 24, 2010