The Unassuming Economist

The noted econometrician writes: “The intermittent failure of economic forecasts to ‘foresee’ the future reflects both imperfect knowledge and a non-stationary and evolving world that is far from ‘general equilibrium’ and closer to ‘general disequilibrium’.”

“[This has] disastrous consequences for dynamic stochastic general equilibrium (DSGE) systems, which transpire to be the least structural of all possible model forms as their derivation entails they are bound to ‘break down’ when the underlying distributions of economic variables shift. This serious problem is highlighted by Hendry and Muellbauer (2017) in their critique of the Bank of England quarterly econometric model (BEQEM–pronounced Beckem: […] a DSGE which, as in the film ‘Bend it Like Beckham’, bent in the Financial Crisis, but so much that it broke and had to be replaced.”

“Surprisingly, despite that abject failure, it was replaced by yet another DSGE (COMPASS: Central Organising Model for Projection Analysis and Scenario Simulation […]. Unfortunately, […] COMPASS had already failed to characterize data available before it was even developed. Persisting with such an approach introduces a triple whammy as:

a] the derivations sustaining DSGEs use an invalid mathematical basis;

b] imposing a so-called ‘equilibrium’ fails to take account of past shifts;

c] the DSGE approach assumes agents act in the same incorrect way as the modeller, so assumes agents have failed to learn that imperfect knowledge about location shifts forces revisions to their plans.”

“During a visit to LSE in 2009, Queen Elizabeth II asked Luis Garicano “why did no one see the credit crisis coming?” to which a part of his answer should have been that DSGE models dominated economic agencies and essentially ruled out such major financial crises by assuming away imperfect knowledge. Prakash Loungani (2001) argued “The record of failure to predict recessions is virtually unblemished.””

The article is available from the here.

IMF’s latest report says that “Growth in Albania is recovering but has recently been driven by large FDI projects, raising concerns about the sustainability of the recovery and underlying growth potential. This study assesses the prospects and challenges for medium term growth. While Albania’s external conditions are favorable, low savings and demographic trends are expected to weigh on investment and labor utilization. However, EU accession literature suggests that institutional reforms as an EU candidate country can catalyze productivity improvements and potential growth in Albania.”

2018 Housing Forecasts collected by Bill McBride:

From a new IMF working paper: “This paper develops new error assessment methods to evaluate the performance of debt sustainability analyses (DSAs) for low-income countries (LICs) from 2005-2015. We find some evidence of a bias towards optimism for public and external debt projections, which was most appreciable for LICs with the highest incomes, prospects for market access, and at ‘moderate’ risk of debt distress. This was often driven by overly-ambitious fiscal and/or growth forecasts, and projected ‘residuals’. When we control for unanticipated shocks, we find that biases remain evident, driven in part by optimism regarding government fiscal reaction functions and expected growth dividends from investment.

A BBC Radio 4 programme quoted my research:

“Prakash Loungani at the IMF analysed the accuracy of economic forecasters and found something remarkable and worrying. ‘The record of failure to predict recessions is virtually unblemished,’ he said.

His analysis revealed that economists had failed to predict 148 of the past 150 recessions. Part of the problem, he said, was that there wasn’t much of a reputational gain to be had by predicting a recession others had missed. If you disagreed with the consensus, you would be met with scepticism. The downside of getting it wrong was more personally damaging than the upside of getting it right.”

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