The Unassuming Economist

From a new post:

“The ONS says GDP grew by 1.4% last year. 1.4% is a significant number: it is exactly what the private sector economists surveyed by the Treasury predicted in December 2017 that growth would be in 2018.

Granted, this bulls-eye might not survive future revisions to GDP estimates. But it reminds us that economists’ forecasts for growth are often not too bad.

My chart shows the point. It compares forecasts made in December for growth the following year to actual growth since 2001. Most of the time, the forecasts aren’t too far out. Where they go badly wrong is in recessions. Economists don’t see these coming. In December 2007 they forecast that GDP would grow 1.9 per cent in 2008. In fact it shrank. And even in December 2008 – after the banking crisis – they grossly under-predicted the depth of the recession.

This fitted the pattern. Back in 2000 Prakash Loungani  wrote:

The record of failure to predict recessions is virtually unblemished. Only two of the 60 recessions that occurred around the world during the 1990s were predicted a year in advance. That may seem like a tough standard to impose on forecast accuracy. Maybe so—but two-thirds of those recessions remained un-detected seven months before they occurred.

In December 1990, for example, UK economists forecast growth of 0.3% in 1991. In fact, we got a 1% drop.

Economic forecasts, then, are reasonably OK except when we really need them.

Why? One possibility, suggested by Loungani, is that economists are slow to update their forecasts in light of news. One bit of evidence for this is that they also under-predicted the boom of 1988 (probably because they over-estimated the adverse effect of the 1987 stock market crash). Another possibility is that mainstream forecasters lack incentives to break with the consensus and predict recessions: it’s better to be wrong in a crowd. It’s for this reason that it is mavericks and those wanting to make a name for themselves who predict doom.

I suspect, though, that there’s something else. It’s that recessions are caused by things which are hard for macroeconomists to discern. For example, Xavier Gabaix shows how they can be caused by failures at large firms. And Daron Acemoglu and colleagues have described how they can be amplified by network  effects: trouble at a firm at the centre of a hub can spill over into other firms whereas trouble at a spoke does not. These are both part of the story of the 2008-09 crisis.

Macroeconomists are tolerably good at predicting fluctuations in aggregate demand. It is other things – such as supply shocks, network and peer effects or banking crises – they’re not so good at foreseeing.

It doesn’t automatically follow, however, that recessions are wholly unpredictable. US evidence strongly suggests that inverted yield curves lead (with a variable lag) to economic downturns. I suspect this is for the same reason that consumption-wealth ratios help predict bad times. It’s because such data aggregates the dispersed and fragmentary knowledge of countless individuals. There some specific conditions when the wisdom of crowds works better than experts.”

From The Irish Times:

“The US economic expansion, now almost 10 years old, is within seven months of becoming the longest in history. However with stocks falling into bear market territory last month amid mounting fears regarding global growth, is a recession around the corner for the world’s biggest economy?

The year began with stocks enjoying a strong rebound while Merrill Lynch’s latest monthly fund manager survey shows only 14 per cent expect a global recession in 2019.

Still, the “overall judgment of financial markets is that recession is significantly more likely than not in the next two years”, warned Harvard professor and former treasury secretary Larry Summers earlier this month, citing bond market movements, softening commodity prices and widening credit spreads.

Globally, most equity markets have fallen into bear markets notes Goldman Sachs, and almost all have experienced double-digit corrections.

Bulls point out that while the stock market is meant to be a leading economic indicator that anticipates the future, it is far from omniscient and has, as Nobel economist Paul Samuelson once quipped, predicted nine of the last five recessions.

Still, there’s no shortage of concerned experts. Summers thinks there’s “better than a 50/50 chance” of a US recession in 2020. “It wouldn’t surprise me at all if we slipped into a recession real soon,” says Nobel economist Robert Shiller, who famously foresaw the popping of the late 1990s technology bubble as well as the US housing crash that ushered in the global financial crisis.

Economist polls

The US economy is expected to continue growing in 2019 but concerns are growing. There is a 40 per cent chance of a US recession in the next two years, according to a Reuters poll of economists last month. A more recent Bloomberg economist poll found a quarter expect a recession in the next 12 months – the highest number in seven years, and one that closely corresponds to economist polls conducted by CNBC and the Wall Street Journal.

(…)

Still, economists rarely see recessions coming. Only two of the 60 recessions recorded (in 77 countries) during the 1990s were predicted a year in advance, according to a 2008 paper by the International Monetary Fund’s (IMF) Prakash Loungani, and 40 were not spotted just seven months before onset. Forecasters are too slow to update their forecasts and are “also slow to absorb news about developments outside their own economies”, leaving the impression they are “chasing the data rather than being a step ahead of it”.

The IMF updated its analysis last year, but the conclusion was unchanged: forecasts are revised too slowly and while forecasters are “generally aware that recession years will be different from other years”, they miss the magnitude of the downturn until the year is almost over.”

Continue reading here.

From a new post by Adam M. Grossman:

“Economist Prakash Loungani has spent the better part of two decades researching the issue. In a 2001 study, Loungani evaluated experts’ ability to forecast recessions. His conclusion was blunt: “The record of failure to predict recessions is virtually unblemished.” In a follow-up study, looking at the 2008 financial crisis, Loungani’s findings were nearly identical. Economists uniformly failed to predict that global recession.

Perhaps Loungani’s study wasn’t comprehensive enough. What about all-star forecasters? Here the evidence is inevitably more anecdotal, but no more encouraging. Consider Abby Joseph Cohen, the recently-retired Goldman Sachs strategist. Her forecasts during the 1990s earned her the nickname “the Prophet of Wall Street.” But she later missed the two biggest meltdowns of her career: In 2000, when the dot-com bubble burst, Cohen predicted the market would rise. And she, along with virtually everybody else, missed the 2008 collapse.

A more recent example: Ray Dalio, the billionaire founder of hedge fund Bridgewater Associates, proclaimed in January of this year: “If you’re holding cash, you’re going to feel pretty stupid.” The year’s not over yet. But so far, cash has done materially better than the stock market, which is in negative territory.

The reality is that forecasting has always been difficult—and not just in the world of economics. Decca Records told the Beatles they have “no future in show business.” Walt Disney was once fired for “lacking imagination.” The list of incorrect predictions is long.

If forecasts are so error-prone, why do sensible organizations like Vanguard continue issuing them? In part, I believe it’s in response to investor demand: People want to know what’s going to happen and they believe experts can tell them. It’s just human nature. But now that you’ve seen the data, here’s my recommendation: Tune out anyone who approaches you with a crystal ball. Instead, situate yourself so the market’s short-term ups and downs don’t impact your ability to meet your financial goals—or to sleep at night.”

A new article from The Economist cites my paper:

“[…] economic forecasters project GDP growth of about 2% in 2020.”

“How much confidence should one have in these predictions? For the past 20 years The Economist has kept a database of projections by banks and consultancies for annual GDP growth. It now contains 100,000 forecasts across 15 rich countries. In general, they fared well over brief time periods, but got worse the further analysts peered into the future—a trend unsurprising in direction but humbling in magnitude. If a recession lurks beyond 2019, economists are unlikely to foresee it this far in advance.”

“The biggest errors occurred ahead of GDP contractions. The average projection 22 months before the end of a downturn year missed by 3.7 points, four times more than in other years. In part, this is because growth figures are “skewed”: economies usually expand slowly and steadily, but sometimes contract sharply. As a result, forecasters seeking to predict the most likely outcome expect growth. However, they adjust too slowly even once bad news arrives, says Prakash Loungani of the IMF. That suggests they are prone to “anchoring”—over-weighting previous expectations—or to “herding” (keeping their predictions near the consensus).”

“If forecasters displayed such biases consistently, an aggregator could beat the crowd by granting more weight to those with good records. But top performers rarely repeat their feats. When it comes to GDP, the best guide is the adage that prediction is difficult—especially about the future.”

From The Economist magazine:

“They perform far better when forecasting growth years than downturns

SOME INVESTORS worry that America will face a recession in the next few years, after one of the longest expansions on record. Stock indices have fallen by 10% since early October. Yields on short-term government bonds exceed those of some longer-dated ones, often a harbinger of a downturn. Despite this, economic forecasters project GDP growth of about 2% in 2020.

How much confidence should one have in these predictions? For the past 20 years The Economist has kept a database of projections by banks and consultancies for annual GDP growth. It now contains 100,000 forecasts across 15 rich countries. In general, they fared well over brief time periods, but got worse the further analysts peered into the future—a trend unsurprising in direction but humbling in magnitude. If a recession lurks beyond 2019, economists are unlikely to foresee it this far in advance.

Economies are fiendishly complex, but forecasters usually predict short-term trajectories with reasonable accuracy. Projections made in early September for the year ending four months later missed the actual figure by an average of just 0.4 percentage points. Errors rose to 0.8 points when predicting one year out. But over longer horizons forecasts performed far worse. With 22 months of lead time, they misfired by 1.3 points on average—no better than repeating the previous year’s growth rate.

 

The biggest errors occurred ahead of GDP contractions. The average projection 22 months before the end of a downturn year missed by 3.7 points, four times more than in other years. In part, this is because growth figures are “skewed”: economies usually expand slowly and steadily, but sometimes contract sharply. As a result, forecasters seeking to predict the most likely outcome expect growth. However, they adjust too slowly even once bad news arrives, says Prakash Loungani of the IMF. That suggests they are prone to “anchoring”—over-weighting previous expectations—or to “herding” (keeping their predictions near the consensus).”

Read the full article here.

A separate article from Bloomberg says that:

“Recession Signs Hard to Miss If Stock Message Is Taken Seriously

Prices bounce around, emotion obscures logic, signals appear and vanish. The reasons for treating equities as a poor barometer for the economy are many. Right now, that might be for the best.

Pools of gloom await anyone looking for a message in stocks. There’s the $3 trillion in value erased, the bloodbath in banks and the trouncing in transports. In wonkier circles, shrinking valuations and negative rolling returns have started to ring the recession bell. A relatively calm week in the Dow Jones Industrial Average just ended with a 495-point thud.

It’s a pastime on Wall Street these days to look at the carnage, add it all up, and announce that the market is wrong. But what if it’s not? After all, even if equities have predicted “nine of the last five recessions,” as the economist Paul Samuelson famously said, that’s a better record than a lot of humans.

(…)

Sure, markets overshoot, and sentiment gets carried away. Corrections like this one have occurred six other times since the bull market began in 2009. They all sparked growth scares. But none of them a recession.

“The market is wrong,” said Anik Sen, global head of equities at PineBridge Investments. “Clearly it has been a slowdown, but the slowdown can be very transitory in our view. At the end of day, there is enormous pent-up demand, whether it’s capex or technology spending. None of that has changed.”

Still, anyone heeding strategist calls shouldn’t forget Wall Street’s propensity to lean bullish. Over the past two decades when stocks suffered two bear markets, professional forecasters have never once predicted a down year. Economists don’t see one now, either. Eighty-nine surveyed by Bloomberg generate an average prediction of 2.6 percent growth in gross domestic product next year.

Meanwhile, a 2014 study by Prakash Loungani of the International Monetary Fund found that not one of 49 recessions suffered around the world in 2009 had been predicted by the consensus of economists a year earlier. Loungani previously reported that only two of the 60 recessions of the 1990s had been anticipated a year in advance.”

Read the full article here.

Also, see a related note on “There will be growth in the spring”: How well do economists predict turning points?