What Are Economists Getting Wrong Today?
(Bloomberg Markets) -- At the height of the financial crisis in late 2008, Queen Elizabeth II asked an economist, “Why did nobody notice it?”
Aside from a handful of dismal scientists branded as doomsters before the turmoil hit, the failure was a collective one for economists from Wall Street to academia.
Indeed, a 2014 study by Prakash Loungani of the International Monetary Fund found that not one of the 49 recessions suffered around the world in 2009 had been predicted by a consensus of economists a year earlier. Further back, he discovered only two of the 60 recessions of the 1990s were anticipated a year in advance.
A decade on from the British monarch’s question seems an opportune time to ask what economists might be missing.
What are economists getting wrong today?
“Given our past record in predicting the economic impact of technology, economists will probably get this wrong again. Today, weak productivity growth seems puzzling at a time of great new technological innovations. But in the past, it took decades for electricity or cars or computers to be fully integrated into our production processes and business practices and to boost productivity growth. Likewise, the internet of things or artificial intelligence will take time to be similarly integrated and to be visible in our measures of productivity. While being well aware that, in the 1930s, [John Maynard] Keynes famously predicted that automation would lead to a three-hour working day, my sense is that this process is likely to speed up and surprise on the positive side.”
—Peter Praet, Chief Economist at the European Central Bank
“If you go back to last year, the tone of IMF discussions in the annual meetings was very optimistic about the synchronized recovery . It was the big theme. I was in Jackson Hole [in Wyoming], at the Federal Reserve conference, last August and spoke at the final panel, and part of my message was, ‘Let’s not confuse recovery with resolution’—that was the theme. I think perhaps we went a little too overboard on the synchronized recovery, I think a more differentiated, a more cautious approach, in the context of Europe, and the context of Japan, is needed.”
—Carmen Reinhart, Professor at Harvard Kennedy School
“A serious problem facing the economics profession is that there remain severe gaps in international economic and financial data . Since there is only partial and incomplete information on the linkages across economies (especially between advanced and emerging economies), the analysis of global economic and financial developments is subject to a high degree of uncertainty. If there were greater international cooperation in collecting and sharing data, our degree of confidence in our economic and financial assessments would substantially improve.”
—Philip Lane, Governor of Central Bank of Ireland
“Economists underestimate the likely rebound in real interest rates in coming years because they attribute too much of the post-crisis decline to structural factors such as lower potential GDP growth. Although economic theory does suggest such a link, the empirical relationship—using cycle-by-cycle averages of real rates and real GDP growth for the U.S. and other advanced economies stretching back more than a century—is loose at best. A better explanation lies in cyclical headwinds that persisted for much of the recovery, such as banking and housing-sector stress, overly tight fiscal policy, and restrictive financial conditions. At least in the U.S., these headwinds have recently turned into tailwinds, and real rates are likely to continue rising in response.”
—Jan Hatzius, Chief economist at Goldman Sachs Group Inc.
“Queen Elizabeth II famously said during the crisis, ‘How did you miss this?’ That did prompt a deep rethinking in macroeconomics and banking and finance of what did we miss. We have a better understanding of the crisis, so that’s good, but most papers stop there, and there’s not much work on what we do about it. You might think that if we know the problem was liquidity or too much debt or too much leverage, then the solution is easy. You don’t need to do a paper, just stop debt—no leverage. But obviously that’s not the solution. We need to think deeply about that, know we’ve got a deeper understanding of the problems, and resolve them. And it’s not as simple as just stopping some of these channels. We need to have a better sense of levels . Too much leverage is a problem, but what’s too much leverage? Too much debt is a problem, but, again, what’s too much debt?”
—Kristin Forbes, Professor at MIT’s Sloan School of Management and a former Bank of England policymaker
“Since the great financial crisis that began in 2008, increasing volatility in financial markets has made it particularly difficult to forecast economic growth. For a long time many countries, including South Africa, had to consistently revise their growth forecasts down as we underestimated the negative impact of the financial crisis on the economy. One of the major challenges that economists faced was to essentially disentangle how much of our growth problems are cyclical and how much are structural.”
—Lesetja Kganyago, Governor at the South African Reserve Bank
“Most macroeconomists, forecasters, and academics alike are still much too influenced by the 1970s. To them, inflation lurks around every corner and is determined by forward-looking expectations, which are liable to jump upwards at any time. This is clearly false with respect to the last 30-plus years—in Japan, in the other advanced economies, and even in emerging markets. Labor bargaining power, openness to trade, and innovation are the primary drivers of inflation trends, especially since national inflation rates are more synchronized than ever. Expectations and inflation are inertial, not just sticky.”
—Adam Posen, President of the Peterson Institute for International Economics and a former Bank of England policymaker
“There’s a divergence between the academic economist and the nonacademic economist. And maybe there has to be more of a conversation. The public thinks economics is all about predicting when the next crisis and the next recession or next upturn will be, and in truth we have very modest abilities to do that. What we can say is there are policies that are more sensible and will reduce the probability of that happening. To some extent we should rectify the balance. I think sometimes, in policy circles especially, they want an answer—“When do you think X is going to happen?”—when in fact we don’t really have much to say about that. We have a lot to say about what do you do to make X not happen.”
—Raghuram Rajan, Professor at the University of Chicago Booth School of Business and former Governor of the Reserve Bank of India
Kennedy is executive editor for economics at Bloomberg News in London. With reporting by Alessandro Speciale, David Goodman, and Rene Vollgraaff.
This story appears in the August / September 2018 issue of Bloomberg Markets.
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