Economists’ inability to predict recessions
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Economists’ inability to predict recessions

A worker using a crane to transfer a roll of sheet aluminium at a factory in Nanning, China’s southern Guangxi region. Photo: STR/AFP

A worker using a crane to transfer a roll of sheet aluminium at a factory in Nanning, China’s southern Guangxi region. Photo: STR/AFP

Economics is not an exact science and predicting major developments in any national economy is riddled with risks of inaccuracy. At present those who follow the international economic situation are wondering when the next global or regional recession is bound to happen after almost a decade of generally benign economic developments.

Economists’ inability to predict recessions is well known. The reasons vary from very understandable human attitudes to the difficulty of interpreting economic data that can often be out of date or inaccurate. To add to the difficult forecasting task that economists face, one can add the way that recessions often erupt suddenly as a result of a financial shock such as stock market panic. The inability of the great majority of economists to predict the 2007 global economic slowdown will never be forgotten.

A recent IMF paper authored by a number of economists including Prakash Loungani discovered that out of 153 recessions in 63 countries from 1992 to 2014, only five were predicted by a consensus of private-sector economists in April of the preceding year. Moreover, economists tended to underestimate the magnitude of the slump until the year was almost over.

Such inability to forecast recessions is not necessarily the result of a lack of skills of economists studying the changes in economic cycles. Some of the reasons have to be sought in human psychology. Groupthink may be a major obstacle. Professional forecasters feel safer agreeing with the crowd of economists’ consensus opinion. Loungani argues that failing to forecast a recession is a much more common error than a warning about one that does not occur.

Of course, there will always be Jeremiahs in the economists’ community who will constantly be predicting a recession because sooner or later they will be proven right. These Jeremiahs often couch their predictions in vague terms like saying that there is bound to be a recession in the coming two years.

Jeremiahs often couch their predictions in vague terms

Politicians are also notorious for making daring economic statements that are more intended to create a feel-good factor among the electorate than a conviction that is based on a study of underlying factors. Who can forget the claim by former Prime Minister Gordon Brown when he was still Chancellor of the Exchequer under Tony Blair when he claimed that he had eliminated the boom and bust cycles of the British economy?

I am also mildly amused by the statements made by some economists when asked by inquisitive journalists whether they believe that a property bubble exists at any point in time in a particular country.

Few economists would risk causing a panic in a property market by declaring that they see a bubble building up because of massive investment in development projects and property prices rising to unaffordable levels. Many will couch their opinions in cautioning that when the supply of property exceeds by far demand, a ‘correction’ in property prices will be inevitable.

Today, one can hardly follow the financial press without noticing the concern expressed by many analysts that the end of the boom years could be near. According to Bloomberg, in a recent survey of its members, the National Association for Business economics found that 42 per cent anticipate a US recession beginning next year, along with 10 per cent predicting one this year and 25 per cent expecting one in 2021. The situation looks even bleaker in the rest of the world.

The slowing of growth in China continues, while Europe is looking fragile. Italy is already in recession and Germany and France very near one. Financial markets give better indications of what is likely to happen. In March, the US bond market flashed the beginning of an inversion of a yield curve – a technical term that indicates that long-term interest rates are lower than short-term ones. An inverted yield curve is usually a harbinger of a coming recession. The big question is when the next recession will hit the major economies.

One positive development is that in the last decade indications emerged that business cycles had been tamed and more soft landings and fewer severe recessions are likely to be experienced. Soft landings are partly due to the mild monetary policies adopted by the Federal Reserve and by the ECB to mitigate the worst risks of economic slowdowns.

Expect to see economic forecasts shrouded in more vague terms as many economists prefer not to be caught out forecasting a recession that never materialises or is only very mild.

johncassatrwhite@yahoo.com

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