Forecasting Failures and the Need for Automatic Stabilizers

From a new post by Chris Dillow:

“Simon has a good discussion on whether fiscal or monetary policy is better at stabilizing output. I’d suggest, though, that neither is in practice particularly good and that what we need instead are stronger automatic stabilizers.

I say so for a simple reason: recessions are unpredictable. Back in 2000 Prakash Loungani studied the record of private sector consensus forecasts for GDP and concluded that “the record of failure to predict recessions is virtually unblemished” – a fact which remained true thereafter.

The ECB, for example, raised rates in 2007 and 2008, oblivious to the impending disaster. The Bank of England did little better. In February 2008, its “fan chart” attached only a slight probability to GDP failing in year-on-year terms at any time in 2008 or 2009 when in fact it fell 6.1% in the following 12 months. Because of this, it didn’t cut Bank Rate to 0.5% until March 2009.

Given that it takes around two years for changes in interest rates to have its maximum effect upon output, this means that monetary policy does a better job of repairing the economy after a recession than it does of preventing recession in the first place. And of course, as there’s no evidence that governments can predict recessions any better than the private sector or central banks, the same is true for fiscal policy.

All this suggests to me that if we want to stabilize in the face of unpredictable recessions, we need not just discretionary monetary or fiscal policy but rather better automatic stabilizers.”

Posted by at 10:10 AM

Labels: Forecasting Forum


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