God is a Capitalist

Sunday, January 22, 2017

Bank of England: mainstream econ is broken

It seems that the Bank of England has been feeling the heat from its forecast that Brexit would plunge the UK into a depression. Added to the failure of mainstream economists to predict the Great Recession, the public is losing confidence in its gurus, according to a story in the Guardian,
Haldane described the collapse of Lehman Brothers as the economics profession’s “Michael Fish moment” (a reference to when the BBC weather forecaster predicted in 1987 that the UK would avoid a hurricane that went on to devastate large parts of southern England). Speaking at the Institute for Government in central London, Haldane [Bank of England Chief Economist] said meteorological forecasting had improved markedly following that embarrassing mistake and that the economics profession could follow in its footsteps.
The bank has come under intense criticism for predicting a dramatic slowdown in the UK’s fortunes in the event of a vote for Brexit only for the economy to bounce back strongly and remain one of the best performing in the developed world.
Before the referendum on divorcing the EU, Bank of England governor Mark Carney had warned that that the split would cause a recession in the second half of 2016. Instead, the UK economy grew at an annual rate of 2.4% in the third quarter with no signs of a slowdown in the fourth.

Haldane defended the missed forecast by saying that consumers and the housing market were more resilient than expected. He stuck to his gloomy prediction by saying recession will ravage the UK in 2017. He said of economics:
"It’s a fair cop to say the profession is to some degree in crisis.” His intention was to highlight the problems inherent in placing too much reliance on large models of the economy which assume people always behave rationally.
Mr Haldane said he hoped the lessons learnt after the financial crisis would help economics move away from “narrow and fragile” models to a broader analysis which encompasses insights from other disciplines.
Former UK justice secretary Michael Gove said: 
Sometimes we’re invited to take experts as though they were prophets, as though their words were carved in tablets of stone and that we had to simply meekly bow down before them and accept their verdict.
I think the right response in a democracy, to assertions made by experts, is to say ‘show us the evidence, show us the facts’. And then, if experts or indeed anyone in the debate can make a strong case, draw on evidence and let us think again – then of course they deserve respect.
Of course, followers of Austrian economics have been doing that for decades but he has ignored them. 

Haldane blamed the profession’s reliance on models that were built for an age when consumers and businesses, and especially banks, “behaved rationally,” adding,  
Since 2008, consumers have maintained their spending when the classic economic models would have expected them to be more circumspect.
The article continued:
 He blamed decades of education policies – that had left numeracy levels in England only just above Albania – for holding back improvements in productivity. He said the lack of numeracy skills was stark in comparison with other countries, which placed more emphasis on workers having more than a basic level of maths.
It’s good that some economists at the Bank of England can admit failure. That is the first step toward recovery from addiction. But blaming the public for being irrational and bad at “maths” shows they have a long way to go.

Austrian economists should never burn at the stake others for missing forecasts because they have known all along such precision is impossible. Hayek lectured in his Nobel Prize speech
The correlation between aggregate demand and total employment, for instance, may only be approximate, but as it is the only one on which we have quantitative data, it is accepted as the only causal connection that counts. On this standard there may thus well exist better "scientific" evidence for a false theory, which will be accepted because it is more "scientific", than for a valid explanation, which is rejected because there is no sufficient quantitative evidence for it.
...I confess that I prefer true but imperfect knowledge, even if it leaves much indetermined and unpredictable, to a pretence of exact knowledge that is likely to be false. The credit which the apparent conformity with recognized scientific standards can gain for seemingly simple but false theories may, as the present instance shows, have grave consequences. In fact, in the case discussed, the very measures which the dominant "macro-economic" theory has recommended as a remedy for unemployment, namely the increase of aggregate demand, have become a cause of a very extensive misallocation of resources which is likely to make later large-scale unemployment inevitable.
Compared to economics, physics is child’s play. The subject of economics, humanity, is far more rich and complex than any of the objects of study of physics, whether black holes or subatomic particles. Since Walras, mainstream economists have done little more than starve the voluptuous field and force it to fit into the math bikini. That's why they get so much wrong. They are left with very little material to work with. 

History of finance is similar. I summarize it in by book, Financial Bull Riding. As a result, financial academics have determined that everything is random, so all an investor can do is buy the market and hold on. But investing is so much richer than that, as many have proven, especially Warren Buffet. 

Yes, mainstream economics is broken, as Haldane said. It has been broken since Keynes. It takes many failures like those Haldane pointed to in order to convince a few, but most refuse to repent. It usually takes a new generation that is open to the truth to make a major change in a field like economics. Maybe the next generation will be it. 

The bottom line for investors is don't trust their forecasts.