The Bank of England will not be able to forecast the next financial crisis or recession, one of its top officials said on Tuesday. “Our models are just not that good,” Gertjan Vlieghe told MPs on the Treasury select committee.
He added that there was not “one model which is right or wrong” and that people had “unrealistic expectations of what we're going to get from economics in the next five years”.
He's right: economics cannot forecast something as important as a financial crisis. But what he did not add is why not, which is down to methodology. Economic forecasts are rational mathematical models. And most assume that behaviour tends to the mean: in other words, if there isn't usually a crisis (and there isn't) then there won't be one coming up either.
Of course I simplify. We know that there are crises. We know that they happen on average every seven to eight years, and that means we're overdue for one. We know that stock market highs, increasing debt and weak economic fundamentals (wage and trade stagnation, both of which look to be on the cards) at the same time suggest fundamental imbalances that can trigger the crash. So just by standing back and using human judgement we can say the chance of there being a crisis in the next five years is very high indeed. But economics can't say that. Because it isn't programmed to do so. Which just shows how far from reality it is. And what a useless exercise conventional approaches to economics represent for society as a whole.
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Hear, Hear!
Even our cosseted monarch wanted to know why none of the economists saw the 2008 crash coming.
‘Orf with their heads One says!’
Also the whole notion of thinking in terms of crisis plays into the mainstream economic worldview, which basically sees crises in terms of crises of economic growth.
Ie. it labels significant/prolonged drops in economic growth as a crisis but for instance, it doesn’t label stagnant real wages as a crisis, or out of kilter house prices as a crisis, or regional economic differences. Even though whatever the next crisis will be, these sorts of things will basically be either the underlying cause, or the thing that tips whatever happens into an actual crisis.
The Bank of England has a wonderful repository of data going back 300 years. If you look at GDP over the last 300 years you find that the average is 1.3% growth per year and the standard deviation is 4.0%. The distribution is consistent with a standard bell curve.
That means we can say that there is 67% probability that growth next year will be between -1.6 % and + 4.3%.
So that is what statistics tells us we can say, basically nothing!
I have the feeling that if we looked at all the indicators (as the meterologists and quants do) and compute like Aladdin at Blackrock we might be able to narrow the error bar but still that means you have to put a number on the black swans like someone starting a war or the likelihood of massive combined fiscal stimulus in both the US and China.
And if you know what is going to happen better keep it secret because if you tell everyone that will change what happens.
Having said all that, I agree there will be a crisis at some point and my guess is that it is coming 🙂
🙂
An intriguing admission with which I assume Mark Carney is in full agreement. Interesting, as he is a vice chairman of the European Systemic Risk Board (ESRB) and a member of the G20 Financial Stability Board! So the ESRB, which has responsibility for avoiding another 2008-style crash and run by the European Central Bank along with individual National Central Banks, comprises the very people who failed to see the disaster in the first place and are unable to see the next! If the BofE position is reflected by other banks these organizations are just very expensive jollies for overpaid bureaucrats; and politicians wonder why there is so much disillusionment with the EU etc.
When largely untaxed land value is the security for most credit and the dysfunctional land market is configured in no economic model, this is hardly surprising.
I well remember when I think the trajectory that’s brought economics to this point started in earnest, Richard, at least at many UK universities. It was 1992 and I’d just started a degree in Public Administration as a mature student (in the days when people who’d previously been in work got a full grant to cover course fees as well as an enhanced maintenance allowance). The department I was a student in was Politics and Economics, reflecting the accepted convention of the day that they were closely related disciplines (note that in this university by the early 2000s economics had migrated to the business school). As well modules dealing with micro and macro economics there were modules in political economy, the economics of the EU, development economics, and various others. And – importantly – there were a range of modules offered by politics staff that complemented these, such as on Marx and other political/economic thinkers, european politics, international relations, and so on.
I was one of many students from the politics side of the department who studied many of the economics modules. Indeed, we were encouraged to do so so that we develop a fully rounded understanding of all of the facets that make up the political economy that most societies are built on. But 1992 also signalled the year that econometrics became a compulsory feature of first level economics and, more importantly, that students who didn’t pass this module could not then progress to studying any other economics modules. As I was not the only public admin/politics student who was not that good at maths – A level maths not being required to register for a degree in public admin/politics – the number of my fellow student who found themselves excluded from studying economics rose rapidly.
When I completed my degree I continued in the same depertment as a sessional lecturer for some years, and during that time it was very evident that the economics part of our department became increasingly dominated by people with a background in mathematics or, to a lesser extent, computing (many computing people have a background in maths, or did at that time). Unsurprisingly the modules they offered began to change: political economy disappeared when the lecturer who taught that module moved on to other things, ditto the economics of the EU, and so on. And of course as that flavour of module disappeared so the modules in politics that had often complemented them also disappeared. In effect the two subjects became seperate. I can still recall being in a pub in about 1996 of 97 and talking to a couple of the newer economics lecturers about this ‘sundering’. I soon learnt that they were not in the slightest bit interested. Indeed, both were at pains to ensure I understood they were ‘not political’. They were only interested in ‘what the numbers tell us’. And that was no suprise as these were maths graduates who were only interested in taking the various ‘theories’ of classical economics and modelling them. And that was the basis of the modules they offered to students and as a result it was no surprise that they primarily appealled to students who were studying maths related subjects, and not to social science students.
I should add of course, that there were other pressures. As in many universities through the 1990 – and indeed ever since – subjects that challenged the neoliberal bent of government and the increasingly free-market and macho management that now dominates UK universities were also discouraged – particularly if the module title suggested any obvious left wing content (e.g. it became anathema to include the terms Marx of Marxist in any module title, or even in module summaries). That said, I still attribute the demise of economics in the UK to the discipline’s capture by maths inspired individuals and the subsequent obsession of many with presenting economics as a physical science – which is, of course, what their values wanted them to believe – rather than the social science we know economics actually is.
(Ps. I’m aware of a good few stalwart exceptions to my portrayal of economists, you included, of course).
The obsession with maths has been the ruin of economic thinking
The serial logical architecture of conventional mathematics although ideally suited to model many problems in physics and so on is utterly incapable of modelling the more complex relationships such as those found in the social sciences. Econometrics is just illiterate drivel. A classic example of what Whitehead called “the fallacy of misplaced concreteness”. Just because you can do sums it doesn’t mean you necessarily understand mathematics. There is a valid application of mathematics in political economy, but it has nothing in common with what is taught in our universities.
Agreed
I too went back to Uni’ but in 1994 Ivan as a mature student when living in LB Lewisham whom I will always hold dear in my heart for paying my grant having moved down from York to be with my newly qualified teacher girl friend (and now the mother of my two kids).
Quite how anyone now would have that chance again I’m not sure but I feel that I have been a very productive member of society ever since.
And I agree – economics is the study of social (and anti-social) behaviour of people within in the various strata of the economy.
It was earlier than that. Neoliberalism was already well established in academe and government when I started an economics degree in 1980. Monetarism was the only respected policy and it started under the previous Labour government, although I doubt whether it would have really flourished here if it hadn’t been for Thatcher. As a mature student, married with young children I had already lived in the real world for some time and I didn’t believe much of what I was taught. Econometrics was the thing and free trade was god. No professor was interested in political economy or history, although some of the teaching staff were. Patrick Minford was spouting his theory that all unemployment was voluntary (you just have to keep lowering your price until someone employs you).
In that case, Carol, I was fortunate that I went to a university that had held out against such stuff (not that it wasn’t taught – e.g. rational choice theory) until the 1990s.
This seems particularly to be a UK problem. My daughter is studying Economics and French and spent last year via Erasmus at studying Economics at Aix-en-Provence (a tough gig!).
She was struck by the difference in teaching. Here the maths component is so much greater than in France where Economics is far more of a Social Science. Fortunately she’s good at sums!