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The Virtues of Contrariness in Economic Forecasting


Henry Lin

By

December 16th, 2012


Following on from the mother of all forecasting blunders – the failure to predict the housing bubble burst and subsequent Global Financial Crisis in late 2007 – can we still trust economic forecasts?


Economists as a whole are notorious for their poor forecasting predictions, which is why the saying “economists predicted nine out of the last five recessions,” is so well known. Economic forecasting is no doubt a difficult task. There are those few economists who are known for ‘getting it right’ or perhaps are just plain lucky. Neither obtaining an economics degree nor working as a professional economist can guarantee success. Of course, no forecasts are 100% correct and we can expect small errors in the numbers. However at times these forecasts are the opposite of actual outcomes and we experience unexpected economic meltdowns like the Global Financial Crisis and the Euro Crisis, during times when economists had predicted strong robust growth. So it isn’t a surprise that the credibility of economists as a whole has come under fire these past few years, and that economic forecasts are taken less seriously than before.

Recall that in July of last year Westpac Chief Economist Bill Evans correctly predicted that the RBA would cut interest rates, while other Australian economists predicted steady or rising interest rates. Other forecast blunders made by a majority of economists with few contrary opinions include overstating India’s huge appetite for our mining exports, predicting that 2012 would be the year of the global recovery, and – the mother of all forecast failures – failing to predict the housing bubble burst and subsequent Global Financial Crisis in late 2007. Of course, economists get it right from time to time, having correctly predicted Quantitative Easing 3, China’s slowing growth, and Europe and the US kicking the can down the road. The fact is economists can have a wide variety of differing opinions amongst each other. Some may be bearish whilst others are bullish about the future economic outlook, and some even predict extreme events like hyperinflation or a return to the gold standard. Economists also differ among one another in the particular economic schools of thought they adhere to, such as Keynesian, Neoclassical and Austrian, for example, which feature different models and fundamental ideas. This in turn leads to massive debates within the field of economics on topics such as austerity vs growth and fiscal vs monetary policy.

Although there are a wide variety of opinions among economists, few managed to predict the Global Financial Crisis. A paper called “‘No One Saw This Coming’: Understanding Financial Crisis Through Accounting Models” by Dirk Bezemer, named 12 economists who had predicted the crash. The majority were commentators, NGO or private sector economists such as Wynne Godley, Fred Harrison, Michael Hudson, Eric Janszen, Jakob Brøchner, Madsen & Jens Kjaer Sørensen, Kurt Richebächer and  Peter Schiff, whilst the remaining four were academics: Steve Keen (Australian!), Dean Baker, Robert Shiller and of course ‘Dr Doom’ Nouriel Roubini.  Notably, most of these economists are not the mainstream economists you and I recognize such as the central bankers, economic advisors to senior politicians, Treasury officials, IMF economists (although Raghuram Rajan did warn about a possible crash, he did not provide a time frame therefore ruling him out of the list of 12) or Nobel Prize winning economists. A special mention goes out to Warren Buffet who isn’t really an economist and didn’t predict exactly when the crash would happen, but was one of the cautionary voices in the years leading up to the crisis, both in relation to risks in derivatives and rising real estate prices.

In reality it would have been very difficult for anyone to predict that Lehman Brothers was going to go bankrupt and cause huge chaos within the financial system, the exact year it would happen and how it would all play out. But still the question remains: why didn’t the wise heads of economics see signs of a housing bubble; aren’t they the experts? And why did they say nothing until it was too late?

Perhaps it was all a “confidence game” to prevent panic in the markets, or their reliance on simple analytical models that blinded them to the looming disaster. Maybe the field of economics was plagued by groupthink and those taking a contrarian view were shunned. Whatever the case may be, economists have trouble correctly predicting the future. What the field of economics lacks is an influential economist/think tank who can accurately forecast the behaviour of the economy correctly. We don’t want overly optimistic economists who are blind to hidden dangers, nor do we want permabears who are constantly cry wolf. But rest assured the world now respects the opinions of economists who are willing to put forward a contrarian view, such as Nouriel Roubini, when it comes to predicting the next recession.

For further reading of why economists failed to foresee the GFC I recommend this link: http://knowledge.wharton.upenn.edu/article.cfm;jsessionid=a830ee2a1f18c5f62020347bf11442669617?articleid=2234

The views expressed within this article are those of the author and do not represent the views of the ESSA Committee or the Society's sponsors. Use of any content from this article should clearly attribute the work to the author and not to ESSA or its sponsors.

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