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Forecasting financial tragedy – who knew

Thursday, January 12 2017

An interesting discussion has taken place on the British Broadcasting Corporation (BBC) regarding the supposed failure of economists to predict the financial crisis of 2008/2009. Such an allegation was made by the Chief Economist of the Bank of England, Andy Haldane. He argued that the profession was “to some degree in crisis” following the 2008-09 crash and the Brexit vote. In terms of the latter, economic forecasts were for a sharper slowdown in the economy than have happened. Since the referendum, the UK economy has had GDP growth at a better-than-expected 0.6% between July and September 2016.

Care has to be taken about Haldine’s comments concerning economists failing to predict the global financial crisis and the housing bubble. Perhaps he was referring to economists in the Bank of England, but certainly this is not reflected in reality. There were at least six rather famous economists who, despite being ridiculed by their peers and others, highlighted the high possibility of a global financial crisis. These economists are Nouriel Roubini (New York University professor), Ann Pettifor, (British economist and Director of Policy Research in Macroeconomics), Steve Keen (Head of the School of Economics, History and Politics, Kingston University), Dean Baker (Co-director of the Centre for Economic and Policy Research) and Raghuram Rajan who, at the time he warned that credit-default swaps and mortgage-backed securities made the global financial system a riskier place, was an economic counsellor at the International Monetary Fund in 2005 and later became Governor of the Bank of India. The last economist is Peter Schiff, (CEO and Chief Policy Strategist at Euro Pacific Capital).

Haldine was also was very critical of the economic models used in forecasting, stating that economic models had been “rather narrow and rather fragile” and worked “fine as long as the going was good”. However, when the globe was “tipped upside down” by the 2008- 09 crisis, these models just did not hack it.

Economic forecasts are after all an economic opinion, a judgement based on analysis. This analysis has to be based on sound models and good timely data. This comment on economic forecast requires closer inspection. There is some validity in the quality of economic models that are used for forecasting but they are very heavily influenced by past events. Nobel Prize winner Paul Krugman has blamed developments in macroeconomic modelling over the last 30 years, and particularly the use of dynamic stochastic general equilibrium (DSGE) models, for this failure. While not attempting to get technical, economic model building requires far more research if these models are to prove useful in pointing to difficulties in the financial landscape.

One common theme among most financial experts is the need for timely and good data. Here the work on the re-engineering of the Central Statistical Office (CSO) in Trinidad and Tobago is critical to ensure the institution can deliver data sets relevant to an evolving economy in a timely manner. It would seem the work by the Task Force is taking long, but while we clearly need faster delivery, it must not come at the expense of quality.

In that regard, the next financial crisis for us may come from unexpected places, perhaps even defaults on motor vehicle loans. Here available data has to come from the Central Bank as well as the CSO. Of course, one only wonders about the stress testing and model building that take place in our institutions. Let us join the debate that is taking place internationally and question our institutions to determine if they can forecast or at least be ready for the next crisis.



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