If you want to know what’s going to happen next, don’t ask an economist
This year’s off-season Winter World Championship was also the first in many years to have had no tournament winner predictions from investment bank Goldman Sachs.
Perhaps, after a string of own goals that saw Goldman’s number-crunchers yell “Brazil win” over and over again, someone finally realized that getting it wrong since 2006 wasn’t the best advertisement for the bank’s predictive power.
One can, of course, dismiss modeling the “beautiful game” as harmless fun, but just two years after Goldman launched his quest for football glory, the 2008 crash showed the limits of economic modeling.
The late Queen Elizabeth, on a visit to the London School of Economics, asked, “Why couldn’t anyone have foreseen it?”.
When a response came, it blamed “financial wizards” who believed they had “found new and clever ways to manage risk” and forecasting failure caused by the “psychology of caution and the mantra of financial and political gurus.”
Fast-forward to today, and on one thing these gurus agree: the certainties of the last few decades are now being thrown into disarray.
It is the end of the “Great Moderation” of the last four decades. The era of low and stable inflation is over, having kept the world economy afloat, central banks are now striving to break it, and the epoch in which globalization brought us a range of ever cheaper commodities has arrived.
The last 40 years may have been great for the investment banks and billionaires, but not so great for people who lost their jobs when China opened up to the world, lost their homes in the crash, or are now seeing incomes eroded by double-digit inflation.
Covid and war are two completely unpredictable events but nobody seems to question the models until it’s way too late
It appears that the predictive power of economic models, whether private sector or official, has not improved significantly since 2008.
At Christmas 2021, the European Central Bank ruled out rate hikes for 2022.
It didn’t turn out that way. Inflation in the Eurozone has doubled to 10% and in 2022 alone there have been 2.5 percentage points worth of ECB rate hikes.
Fast forward to Christmas Eve 2022 and we have one of the ECB’s top officials issuing an unusual warning of further pain in an interview with the German newspaper Frankfurter Allgemeine
newspaper.
ECB Governing Council member Isabel Schnabel said that after initially underestimating the persistence of inflation, the bank will continue to rise until it is brought under control. She warned that interest rates in the euro zone could rise above three percent.
Vicinity
Isabel Schnabel is a board member of the European Central Bank. Photo: Alex Kraus/Bloomberg
Like Goldman, Ms. Schnabel relies on standard economic models—driven by historical data—to give her an indication.
“Models exist, but are difficult to implement in practice. The challenge is to identify the causes of inflation and the right response in real time,” she told the newspaper.
Nobody disputes that policy making is very difficult and that Covid and the war in Europe are two completely unpredictable events, but nobody seems to question the economic models until it is far too late.
It wasn’t the use of models or the invasion of Ukraine that brought ECB economists down in spring 2022.
When the recession comes, it will not be short and shallow, it will be long and severe
In March, even before inflation had risen sharply, it issued a mea culpa for staff inaccurate inflation forecasts, which formed the basis of decisions by Ms. Schnabel and other rate-setters at the bank.
“The underestimate for the first quarter of 2022 marked the largest inflation error of a quarter since the first expert forecasts in 1998 – a difference of 2.0 percentage points between the result and the December 2021 projection,” the bank said.
That statement is equally interesting for what it doesn’t say – it’s not like the ECB has been very good at forecasting inflation before.
According to economist Zsolt Darvas, writing in 2018, the ECB was “systemically wrong” when it adamantly predicted a rise in core inflation since December 2013, the first time its forecasts were released.
This is not a new problem. A study by the International Monetary Fund of 153 recessions between 1992 and 2014 showed that in April forecasters expected output to fall in only five of them before the onset of the downturn.
Where are we now in the economy?
Opinions range from “the mother of all debt crises” to “Doctor Doom” – which became famous for predicting the 2008 crisis and has been predicting it ever since – to an optimistic assessment of Goldman.
She puts the probability of a US recession at 35 percent, well below the median 65 percent among forecasters in the latest Wall Street Journal survey, and says the Federal Reserve will hike interest rates to 5-5.25 percent.
For Europe, she expects a mild recession and the ECB will continue to rise, although there will be no quick recovery from the recession due to the ongoing drag from energy costs.
As befits his nickname, Dr. Doom: “When the recession comes, it won’t be short and shallow, it’ll be long and severe,” but wisely he doesn’t give a timeframe.
Perhaps the only way to understand this is to consult someone who is successful at Worlds predictions. Not Paul the Octopus from 2010, but Liberum Capital’s Joachim Klement, who just completed a hat-trick by picking every winner since 2014.
“It has become a tradition among banks to make these forecasts to show that economists have a sense of humor (they don’t) and can predict really important things,” Mr Klement wrote in his predictions ahead of the Qatar kick-off .
“They can’t. Or rather, most of them can’t.”
https://www.independent.ie/business/world/if-you-want-to-know-whats-going-to-happen-next-dont-ask-an-economist-42249157.html If you want to know what’s going to happen next, don’t ask an economist