And a coda
defends experts against Aditya Chakrabortty
A recent
conversation got me thinking about different types of macroeconomic
forecast error, and what implications they might have for
macroeconomics. I’ll take three, from a UK perspective although the
implications go well beyond. The errors are the financial crisis, the
lack of a downturn immediately after Brexit, and flat UK
productivity.
The immediate cause
of the Global Financial Crisis (GFC) was the US housing market crash,
but that alone should have caused some kind of downturn in the US,
with limited implications for the rest of the world. What caused the
GFC was the lack of resilience of banks around the world to a shock
of this kind.
Were there any
indications of this lack of resilience? Here is an OECD series for
banking sector leverage in the UK: the ratio of bank assets to
capital. The higher the number, the more fragile banks are becoming.
UK Banking sector
leverage: Source OECD
The first and
perhaps most important problem with forecasting the financial crisis
was that macro forecasters were not looking at data like this. For
most it was not on their radar, because banks, let alone bank
leverage, played no role in their models. It was a sin of omission, a
big gap in our macro understanding. (Whether, if forecasters had been
having to forecast this data, they would have predicted a crisis is
improbable, but some would have at least noted it as an issue.)
Moving on to the second mistake, it is often said (correctly) that forecasters are very bad at predicting turning points
or dramatic changes. But many did predict such a change immediately
following the Brexit vote: a sharp and immediate slowdown in
demand caused by the uncertainty of Brexit. It didn’t happen. The
main reason was consumption, which held up by more than people were
expecting, given the fall in real incomes that was likely to come
from the Brexit depreciation. There are two and a half obvious
explanations for this. First, because of Leave propaganda half the
population thought Brexit would make them at least no worse off.
Second, those who did anticipate the rise in import prices may have
taken the opportunity to buy consumer durables made overseas to beat
the prospective price increase. The half is that the Bank cut
interest rates a bit.
None of these
effects are very new. They may not have been incorporated into the
forecasters’ models, but they could in principle have been
incorporated using the forecaster’s judgement, although getting the
quantification right would have been very difficult. In the end we
got the slowdown, but delayed until the first half of this year, as
Leavers began to face reality and the higher import prices came
through, so it was an error of timing more than anything else
(although it was apparently enough to make MP Liz Truss change her
mind and support Brexit!). You could describe it as an unchallenging
error, because it could easily be explained using existing ideas. It
is the kind of error that forecasters make all the time, and which
makes forecasting so inaccurate.
The third error was
UK productivity, which I talked about at length here.
Until the GFC, macro forecasters in the UK had not had to think about
technical progress and how it became embodied in improvements in
labour productivity, because the trend seemed remarkably stable. So
when UK productivity growth appeared to come to a halt after the GFC,
forecasters were largely in the dark. What many like the OBR did,
which is to assume that previous trend growth would quickly resume,
was not the extreme that some people suggest. It was instead a
compromise between continuing no growth and reverting to the previous
trend line, the second being what had happened in previous
recessions.
My point of writing
about this again is that I think this third error is much more like
the GFC mistake than the post-Brexit vote mistake. In both cases
something important that forecasters were used to taking for granted
started behaving in a way that had not happened since WWII. Standard
models were used to treating technical progress as an unpredictable
random process. Now it is just possible that this is still the case,
and the absence of technical progress in the UK and to a lesser
extent elsewhere is just one of those things that will never be
explained. But for the UK at least the coincidence with the GFC,
austerity and now Brexit seems too great. As as I showed in the
earlier post
growth has not been exactly zero but has oscillated in a way that
could be related to macro events.
If there is some
connection, both in the UK and elsewhere, between the decline in
economic productivity growth and macroeconomic developments, then
this suggests an important missing element in macromodels. And like
the financial sector, there is an existing body of research that
economists can draw on, which is endogenous growth theory. There are
examples
of that happening already.
But I want to end
with a plea. After the financial crisis too many people who should
have know better said that failing to predict the financial crisis
meant that all existing mainstream macroeconomics was flawed. It was
rubbish, but such attitudes did not help when some of us were arguing
against austerity on the basis of standard macroeconomic ideas and
evidence. Now with UK productivity, we have Aditya Chakrabortty
saying
that experts at the OBR “are guilty of a similar un-realism and
they have proven just as impervious to criticism” as people like
Boris Johnson or Liam Fox. Not content with this nonsense, he says
“This age of impossibilism is partly their creation”.
This is just wrong.
Look at the elements of neoliberal overreach.
Economists didn’t start calling for tight immigration controls and
using immigrants as a scapegoat for almost everything. Most academic
economists did not call for austerity. Almost all economists did not
want to get rid of our trade agreements with the EU. Even if
economists had warned about the financial crisis they would have been
ignored because of the political power of finance. If all economists
had thought productivity would continue flat we would have just had
more austerity. [1] And in making this basic mistake, it is
ironically Aditya Chakrabortty who has joined Michael Gove and other
Brexiteers in having had enough of experts.
[1] Less expected
productivity growth means lower future output which means lower
future tax receipts which means, given the government’s austerity
policy, more cuts in public spending.
