Finance: Research, Policy and Anecdotes

Andy Haldane, the Bank of England's Chief Economist and known for thoughtful and sometimes provocative statements (remember the dog and the frisbee), has again stirred controversy acknowledging that economists have been wrong in their predictions about the immediate economic effect of the Brexit vote last June.  Does this imply our profession is in crisis?  Here are my two cents: 

First, economic forecasting has always been rather inaccurate and - unlike weather forecasts - I am not convinced that it has become better over the past decades - rather given the ever increasing complexity of economies and interdependence across countries, forecasting might have become more difficult. The simple reason: we are dealing with humans whose behaviour and reaction to events is never perfectly predictable.  This also explains why recessions and crises are hard if not impossible to predict (especially in terms of their timing). 

Second, economists are in much better shape when it comes to explaining economic relationships and predicting longer-term reactions (e.g., increase interest rates and you will see a reaction in both financial and real economy; disrupt trade relationship and societies as a whole will be worse off).   Though even here, we often get it wrong and partly for the same reason as above.  While we often predict the correct direction of changes in economic aggregates and ratios, we are often off in terms of the magnitude.  And where we are even off in terms of the direction of changes, there might be opposing factors whose relative importance we mis-estimate.  In addition, to dealing with human behavior, we also face constantly changing environments and limited data.

Where does this leave us? One, be more humble in stating what we know and what we still have to learn and that current knowledge is no guarantee of not having to update this knowledge constantly. Two, constantly questioning conventional wisdoms and pushing forward the knowledge frontier, with new models, data and methods. 

Does this imply our profession is in crisis or we are facing a continuous challenge?  I'd prefer to think it is the latter rather than the former.  But I am glad that people like Andy remind of the challenges!  

7. Jan, 2017