To paraphrase Oscar Wilde, to fail to forecast a few recessions may be misfortune, to fail to forecast nearly all of them seems like carelessness. Do forecasters simply not update their forecasts often enough to be alert to the onset of recessions? That simple possible explanation turns out not to be true. As shown in Figure 2 earlier, the consensus forecasts in recession years are revised every month; they just are not revised down enough to capture the onset of recessions. Related work by one of us – which looks at the behaviour of individual forecasters rather than just the consensus – also finds that forecasts are updated quite often (Dovern, Fritsche, Loungani, Tamirisa, 2014).
So the explanation for why recessions are not forecasted ahead of time lies in three other classes of theories, which are not mutually exclusive.Sponsored Ads
- One class says that forecasters do not have enough information to reliably call a recession. Economic models are not reliable enough to predict recessions, or recessions occur because of shocks (e.g. political crises) that are difficult to anticipate.
- A second class of theories says that forecasters do not have the incentive to predict a recession, which – though not a tail – event are still relatively rare. Included in this class are explanations that rely on asymmetric loss functions: there may be greater loss – reputational and other kinds – for incorrectly calling a recession than benefits from correctly calling one.
- The third class stresses behavioural reasons for why forecasters hold on to their priors and only revise them slowly and insufficiently in response to incoming information (Nordhaus 1987).
Regardless of the explanation for why recessions fail to be forecasted, the evidence suggests that users of these forecasts need to be cognizant of this feature. Forecasters may be predicting that “there will be growth in the spring” but their ability to predict a sudden snowstorm is rather limited.
Every big financial crisis has its own defining characteristics, but both in origin and consequence, such implosions tend to be remarkably similar. In virtually every case, you first see a long period of excess in financial risk-taking, where credit spirals out of control. This ultimately proves unsustainable, and in the resulting bust the process of credit expansion goes violently into reverse, causing often catastrophic economic damage, from which it will typically take many years to recover. There is no quick bounce back from recessions caused by financial crises.
In one important respect, however, the present maelstrom is unique. Never before have we seen a financial crisis result in such all-encompassing and explosive growth in public indebtedness. This is not a problem exclusive to Britain, nor is the UK even the worst example of it. To a greater or lesser extent, all advanced economies that were directly involved in the financial crisis have suffered the same phenomenon, with public debt climbing to previously unthinkable levels. This might be understandable in the event of a no-holds-barred military conflict, where nations are fighting for their very existence, but for public indebtedness to be approaching such extremes in peacetime is quite without precedent.
Unprecedented relative peace and stability since the end of World War II is being followed by an unprecedented financial crisis. Well, it would be unprecedented if it weren’t so heavily suppressed by heavy borrowing.
Where have we seen this picture before? Things going along just great, then bang – everything falls apart. Does that remind you of the Arab Spring? There was the 9/11 attack. There was a slow motion version of this with the Soviet Union and Chernobyl – the bang moment. There was the Pearl Harbor attack by Japan. There was assassination of Archduke Franz Ferdinand of Austria which started World War I.
Here are some more bang moments:
How to Build a Better Economic Model
In the summer of 1988 Yellowstone National Park experienced a fire unlike anything ever seen before in that park. Initially, there was no indication that this fire was going to be exceptional. It started off like any other fire, but by the time the fire was ultimately put out over 1.5 million acres of land was burned. Prior to that fire the biggest fire ever recorded in Yellowstone was in 1886 where 25 thousand acres burned. Between 1886 and 1988 the policy of the forestry department was to put out or mitigate every fire (stabilize the forest). Paradoxically, this policy pushed the park into complete collapse.
In 2010 economists are trying to figure out how they can prevent the next collapse. When the U.S. financial system was prevented from collapsing in 1997 (the Long Term Capital Management collapse), we got the tech market collapse of 2000-02. When the Fed did everything to mitigate the collapse of the tech market, we got the housing bust of 2007-09. When the housing bust turned into the global financial crisis, the government did everything it could to mitigate the collapse. Now many are wondering if we will experience a double-dip recession in 2011-12.
Both in financial matters and war, countries experience a bang moment when the wheels fall off. Suppressing the bang moment only makes things worse down the road.
China’s massive bank financed stimulus was intended to keep the economy moving. It may instead lead to economic disaster.
Flooding the economy with trillions of yuan in new loans did accomplish the principal objective of the Chinese government — maintaining high economic growth in the midst of a global recession. While Beijing earned plaudits around the world for its decisiveness and economic success, excessive loose credit was fueling a property bubble, funding the profligacy of state-owned enterprises, and underwriting ill-conceived infrastructure investments by local governments. The result was predictable: years of painstaking efforts to strengthen the Chinese banking system were undone by a spate of careless lending as new bad loans began to build up inside the financial sector.
If trying to maintain economic stability in the face of a global economic storm leads to calamity, then what does that say about stabilization efforts in the West during normal recessions? Why is the West today facing an economic storm? It is because of stabilization efforts since 1945. Systematic stabilization efforts since 1945 have ultimately led the West to calamity. China’s efforts to catch up with the West have largely succeeded – China is approaching calamity too. The bigger the stabilization required, the closer one is to calamity.
“Recessions are a natural economic feature and their regular occurrence is healthy and indeed essential,” is how Deutsche’s Jim Reid introduces his investigation into post-Fed un-natural business cycles. Without them there is a serious danger of bubbles and the misallocation of resources as the further market participants detach themselves from the last downturn the more they tend to under-estimate risk.
Until flaws in the euro are addressed, the crisis is likely to simmer on
Spain’s banks are in a world of trouble, as you’ve undoubtedly heard. They are strained by loans made over the course of a a building boom that went bust in 2008, two recessions in the last three years, and the highest unemployment rate among developed nations. Misguided austerity policies have only made things worse. Everybody is biting their fingernails, trying to figure out if the bailout Brussels recently concocted will work. Stocks are reacting in an up and down roller-coaster ride. Depositors are taking their money out of banks in the most vulnerable countries. The biggest fear is that if the bailout fails, the contagion will spread even further into Europe’s core and eventually to the shores of the US itself.
Unless leaders in Europe act quickly, the financial crisis there could drag down the global economy and kill what appears to be a “fragile, extremely uneven” recovery, the multi-national Organization for Economic Cooperation and Development warned today.
In a stark report calling for action aimed at boosting and shoring up Europe’s economies, OECD Chief Economist Pier Carlo Padoan warns that “the crisis in the euro zone remains the single biggest downside risk facing the global outlook.”
If the global financial crisis started in late 2008, why after over 3 years is the recovery only fragile? Do you see something wrong here? We are following the path of Japan, but we don’t really understand Japan’s path. Japan doesn’t either. Why can’t we get out of this mess?
We are in an economic depression that is being heavily suppressed, so it doesn’t feel like a depression. This is different than past recessions. We have now reached the end of the line. We have kicked the can so long that we have reached the end of the road.
All the good news (low inflation, high employment, rising stock and real estate prices) drove economic growth. Between 1982 and 2007, there were only two mild recessions. The economy seemed less risky. Economists announced the Great Moderation of business cycles.
Booms become busts because justifiable confidence becomes foolish optimism. So it was. Believing the world less risky, people took more risks. Investment banks and households increased their debt. Lending standards eroded, because borrowers’ repayment prospects were thought to have improved. Regulators relaxed oversight, because markets seemed more stable and self-correcting. On the fringes, ethical standards frayed; criminality increased. The rest, as they say, is history.
An exclusive conversation with Nouriel Roubini and Ian Bremmer on the toll of war with Iran — and why China and Russia just don’t care anymore what the United States thinks of them.
It’s a mixed bag these days. Europe appears to have arrested its fall into the abyss and the U.S. economy is finally looking up. But with a looming consensus that war with Iran is in the offing and Putin’s recent return to power in Russia, geopolitical chaos lurks around the corner. Foreign Policy once again turned to Nouriel Roubini — who’s always good for a little doom and gloom — and Ian Bremmer to make sense of the ticking time bombs. And they didn’t hold back.
When asked about the consequences of war in Iran, Roubini sees prolonged high oil prices “$170, $180, $200 a barrel” and warned of the knock-on consequences: “the last three major global recessions … were all caused by a geopolitical shock in the Middle East that led to spike in oil prices.” But Bremmer’s not buying all the war hype: “the Obama administration does not want to engage in military strikes against Iran — and they sure as hell are going to resist it, no matter what — before the elections.”
Last week the National Institute of Economic and Social Research, a British think tank, released a startling chart comparing the current slump with past recessions and recoveries. It turns out that by one important measure — changes in real G.D.P. since the recession began — Britain is doing worse this time than it did during the Great Depression. Four years into the Depression, British G.D.P. had regained its previous peak; four years after the Great Recession began, Britain is nowhere close to regaining its lost ground.
Nor is Britain unique. Italy is also doing worse than it did in the 1930s — and with Spain clearly headed for a double-dip recession, that makes three of Europe’s big five economies members of the worse-than club. Yes, there are some caveats and complications. But this nonetheless represents a stunning failure of policy.
And it’s a failure, in particular, of the austerity doctrine that has dominated elite policy discussion both in Europe and, to a large extent, in the United States for the past two years.
Capitalism needs a fundamental overhaul. That capitalism is somehow broken has become one of Davos’ most persistent themes.
The Arab Spring must end happily. Representatives from the revolutionary movements that recently toppled regimes in Tunisia, Egypt and Libya are among the stars of this panel.
The Eurozone crisis will continue to muddle along, but muddling may be enough. The European finance ministers in attendance are all staying on message: Eurobonds are not happening, austerity measures are the way forward now, greater fiscal union is the end goal, and Greece will not default or leave the Eurozone.China is still the star. Brazil has come to Davos in a big way. As has Mexico, and India, and Azerbaijan. But the panels on China are packed,…Americans and Europeans are pointing fingers at each other. Why is the global economy not in full recovery?
Here is my take on these issues:
1. Capitalism is not broken. We are in a crash state because the genius economists and politicians decided that suppressing recessions is a good thing. The build up of corruption and bad decisions has now crashed the system.
2. The Arab Spring will end badly with Islamists coming to power.
3. The Eurozone will muddle along until something happens to make it crash.
4. China is a star that is going to crash soon.
5. Both Americans and Europeans are at fault. The recovery cannot start until the corruption and bad decisions are released. No crash equals no recovery. Let’s default – burn out corruption and bad decisions – and move on. Embrace small recessions going forward.