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The hopelessly confused macroeconomist
Economists make confident assertions in op-ed columns and on cable news—so why are their explanations often at odds with equally confident assertions from other economists? And why are all economic predictions so rarely borne out?[Source]
Extracts from an article in The Economist:
BACK in October 2008, just after the investment bank Lehman Brothers collapsed, the International Monetary Fund unveiled its forecasts for growth in 2009. The IMF is the global lender to national governments; its economic pronouncements are highly respected. So what did it predict? The US would grow 0.1% in 2009, countries in the euro zone 0.2% and the world as a whole 2.6%. The actual outturns were declines of 3.5%, 4.2% and 2.6% respectively.
Economists have regularly failed to predict recessions and were completely caught out by the recent financial crisis, as the Queen famously noticed.
The shortfalls of the profession are old news. All the way back in 1994, Paul Ormerod wrote a book called The Death of Economics, lamenting the failure to forecast the Japanese recession or the collapse of the Exchange Rate Mechanism, from which Britain was turfed out in 1992. “The ability of orthodox economics to understand the workings of the economy at the overall level is manifestly weak (some would say it was entirely non-existent)” Ormerod wrote.
To be fair to economists, there are two reasons why their forecasts are often likely to be wrong. The first is that humans are not inanimate objects; we change our behaviour and we watch the news. If every economist forecast a recession for 2013 and the predictions were widely publicised, businesses would cancel their investment programmes and consumers would start saving, not spending, for fear of losing their jobs. The recession would occur now, not next year. [Sanjeev: This is hubris of an extreme order! No sane businessman EVER listens to economists!]
Second, the economy is a complex mechanism with many working parts. Economists cannot run real-time experiments in the same way as scientists; operating one version of the economy with high interest rates and another with low rates, as a pharmacologist can offer one patient a new drug and another a placebo. There is no way of isolating the various factors that affect growth.
But there are more fundamental questions about the nature of the subject beyond the failure of economists to make accurate forecasts. Do economists have an accurate model of human motivation? Or do they assume that our motives are entirely mercenary?
In his excellent book, “The Assumptions Economists Make” Jonathan Schlefer tries to go back to first principles. Economists, he writes, “make simplified assumptions about our world, build imaginary economies based on those assumptions – otherwise known as models – and use them to draw practical lessons.” This is, as he admits, inevitable; the economy is too complex for any other approach to work. Simplified models can be manipulated mathematically to produce answers to economic problems. But it is easy to get carried away by the elegance of the model, and to forget the short cuts that were taken when the simplified assumptions were made.
The Chicago/neoclassical school tends to build up from the micro level, looking at the way that rational individuals will respond to incentives. The Keynesian school sees that the aggregated response of rational individuals might have perverse outcomes, as in the paradox of thrift, so calls on the government to take action in response. The Keynesians [are] reluctant to acknowledge that there may be a limit to the effectiveness of government intervention.
[Sanjeev: In my view BOTH schools of macroeconomics are deeply flawed. There is SIMPLY NO WAY to model entire economies without understanding (a) the entrepreneur and (b) incentives of the bureaucrat and politician. We need the insight of Schumpeter and Buchanan, along with detailed knowledge of the actual situation that is often known only to specialists in individual industries (e.g. housing finance industry). Since no human can have all this information, there can only be some broad medium and longer term generalisations made about the economy.]
Read more at Sanjeev Sabhlok’s Occasional Blog-Economics
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