Forecasting the failure of economics


by Chris Becker

A very dry article via CBS popped up in the Twittersphere today that tried but failed to explain the inability of economics – as a profession – to forecast:

The Queen of England famously asked why economists failed to foresee the financial crisis in 2008. “Why did nobody notice it?” was her question when she visited the London School of Economics that year.

Economists’ failure to accurately predict the economy’s course isn’t limited to the financial crisis and the Great Recession that followed. Macroeconomic computer models also aren’t very useful for predicting how variables such as GDP, employment, interest rates and inflation will evolve over time.

First of all note how its only in Australia where “the Great Recession” is called the GFC. But seriously, this article does try to paint a mechanical picture of why things can go wrong, without addressing the fundamental issue behind economics itself.

That is the neoclassical dominance and its fervent belief that an economic system interdependent on human behaviour and random exogenous events (e.g drought or a riot in Hong Kong) can be modelled accurately all the while ignoring or vastly simplifying the great monetary machine that drives it.

So the problem does not lie with bad data, or bad luck or modelling errors – the first excuses run off the list – but the very concept of trying to model and forecast such a system. The article tries to steer itself into the light of truth:

Inherent randomness: Sometimes it doesn’t matter how good the model is. Given our current state of knowledge, there’s no way to forecast the future about a lot of things. Think of earthquakes and the weather. Even though we have a pretty good understanding of the science underlying both, we still can’t predict them very well. That could change as our scientific knowledge improves, but for now the weather, say, a year from now or the occurrence of an earthquake is mostly a random event.

We do not want to believe that future outcomes are undeterminable, nor do we want to acknowledge when looking back that it was unforeseen and unknown and unconnected variables that caused x, y or z from happening. Instead, we are wired to tell a story and its usually the economists with the loudest voices (or biggest beards?) that make the best storytellers, even if its just a work of fiction, and its their pretty models and application of such falsehoods that lead us into trouble.

There have been some good models developed that can cover some aspects of the economy and markets (some of Steve Keens work on financial instability and of course, Bridgewater which adopts a matrix style model of potential outcomes), but what economics needs to do is move away from precise forecasts and adopt basic risk management techniques giving a range of probabilities.

All the while admitting that they do not know what next years or even next months unemployment print will be, or where the economy will be in five years time.

And perhaps taking a step back and realise that economics is a study of human behaviour, not one of financial mathematical modelling.


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