On February 2, 2015 the Federal Reserve Bank of San Francisco (FRBSF) published an Economic Letter titled “Persistent Overoptimism about Economic Growth.” (pdf)
This Economic Letter has many notable aspects. Here are some excerpts that I found particularly notable, although I don’t necessarily agree with them:
Economic forecasting can be a humbling endeavor. In a cross-country study of private-sector forecasts from 1989 to 1998, Loungani (2001) finds that “the record of failure to predict recessions is virtually unblemished.”
An updated study by Ahir and Loungani (2014) finds that the private-sector’s record of failure to predict recessions remained intact through 2008 and 2009.
Notwithstanding the typical failure to predict recessions, it is worth considering whether some warning signals about the Great Recession went unheeded.
Recessions triggered by financial crises are typically preceded by sustained episodes of bubbly asset prices and debt-financed spending booms.
also (under “Implications for economic models) :
Research has identified numerous instances of persistent bias in the track records of professional forecasters. These findings apply not only to forecasts of growth, but also of inflation and unemployment (Coibion and Gorodnichencko 2012). Overall, the evidence raises doubts about the theory of “rational expectations.” This theory, which is the dominant paradigm in macroeconomics, assumes that peoples’ forecasts exhibit no systematic bias towards optimism or pessimism. Allowing for departures from rational expectations in economic models would be a way to more accurately capture features of real-world behavior (see Gelain et al. 2013).
I have featured various economic forecasts that preceded the Financial Crisis on the “Predictions” page. Additionally, I highlighted various aspects of the Wall Street Journal economic forecast survey of August 2008 in the post titled “A Look Back – 2008 Economic Forecasts.” Needless to say, virtually all professional forecasts not only failed to predict the Financial Crisis, but as seen in the August 2008 Wall Street Journal poll, they almost evenly split as to whether the U.S. was then even experiencing a recession.
My analyses indicates there are many reasons for over-optimism in economic forecasts as well as other flaws and resulting incorrect conclusions in prominent professional economic analyses. Many of the reasons are complex, and as such aren’t suitably discussed in a brief manner.
However, one aspect that is highly disconcerting was the inability of professional forecasters as well as policymakers to predict or otherwise foresee the Financial Crisis, even though there were many obvious “signs” at the time of (highly) problematical aspects.
While some would view this performance as being in the past – and as such not necessarily relevant to the future – I would argue that is exceedingly relevant in many ways.
If one believes, as I do, that the overall economic and financial environments have (greatly) increased in complexity since the Financial Crisis, it bodes poorly with regard to the expected accuracy of professional forecasts with regard to the next financial crisis. More importantly, based solely upon the “track record” of these professional economic forecasts, can it be reasonably assumed that the next financial crisis can be forecast if not successfully avoided?
The Special Note summarizes my overall thoughts about our economic situation
SPX at 2057.46 as this post is written