Andy Haldane has recently come out to apologise about the forecasts the Bank of England and experts had made in the wake of the EU Referendum. After having missed the occurrence of the 2008 financial crisis and totally misjudged the Brexit vote, is the Bank in disrepute?
Claims made by leading economic thinkers include statements of ‘fact’ (when it comes to experts providing opinion, the average Joe Public will take this as fact) such as:
“Britain’s shock vote to leave the EU has unleashed a wave of economic and political uncertainty that likely will drive the UK into recession,” Samuel Tombs, Pantheon Macroeconomics.
David Owen, the chief European economist at Jefferies International, said a technical recession – two consecutive quarters of contraction – may now be a given, followed by a period of very slow growth. He also said the UK’s long-term economic potential, known as trend growth, would be lower, “which has to impact the valuation of assets, particularly equities”.
George Osbourne tweeted:
…as a result of Mark Carney’s presser which can be seen here, where they also expected a 20pc fall in the pound, which, by the way, was totally not unexpected – you can read about this in an article I wrote a month or two ago. In actuality, post referendum, we are experiencing very good economic conditions. Business confidence is up in Q4 2016 vs Q3 2016, inflation is at the highest level in 2 years (yet Andy Haldane is now arguing that inflation is going to hurt British consumers, after being a dove for a long time – talk about flip flopping), one of the biggest industries, construction, is seeing a boom, even in the face of higher material costs for builders, and finally, UK Q4 growth was better than expected.
This isn’t meant to be a total critique specifically of the post referendum expectations from the Bank and many expert economists, but a critique of forecasting of many events by economists, as well as their decision making along the line.
Consistently through history, economists have misjudged or mis-forecasted events, from the Great Depression, to Reagan’s ‘Trickle-down economics’, which many still feel holds weight today, to the predicting the financial crisis of 2008.
In 1999, The Economist wrote to the UK’s leading academic practitioners of the dismal science to find out whether it would be in our national economic interest to join the euro by 2004. Of the 165 who replied, 65 per cent said that it would. Even more depressingly, 73 per cent of those who actually specialised in the economics of the EU and of monetary union thought we should join – the experts among the experts were the most wrong.
I believe that it is because although economists use varying models, these models are consistently going to be outdated where human behaviours change according to environmental, technological, financial and resource bases advances and evolution. Models used 70/80 years ago are still being used today. A model that worked in a post war world doesn’t necessarily work today. It could lead you to ask why have interest rates consistently been on a decline for 30 years? Why are real wages decreasing long term? Evidently something is wrong with our economic system and I believe that a key reason for this is the lack of credible forecasting from our central banks and government economists, as well as other variables such as increasing inequality, which I think can also be attributed to certain post war mechanisms (hint, baby boomer created mechanisms).
In trading, you can argue that an analyst can have a totally different view of the market to a trader. The issue is that one is well, analysing, and one is actually putting their balls on the line and aiding price discovery – and everything is based on price discovery or supply and demand equilibrium. What is the punishment for Andy Haldane saying that there is the ‘potential’ for a post referendum recession apart from having to make an apology? Not much apart from a red face and an article critiquing him by an MT4 FX trader. A trader would lose or gain. There is something on the line but this leads me onto something that I feel economists totally forget about markets.
Pricing in is the notion that the market discounts everything. The price you view now is the price of all information known in the market. For example, one could look at the dollar rally we experienced from late summer to the December rate hike and consider the high of 118.5 as that being the market including all information based on the belief that a hike would have occurred, since we are now trading 200-250 ticks off of that price. The dollar tends to fall after US rate hikes anyway for about 6 months after. Slight tangent there, but the point is that economists tend to miss this a lot. Traders do not. A 15% fall in GBP was predicted by the IMF a year before Brexit. Traders knew this – they’d been shorting cable from $2.00 highs. They were just waiting for a catalyst to be able to capitalise on that fall – and in my opinion, it would have occurred anyway over time.
It’s the same with the Trump vote. There were heavy predictions of a stock market crash… we are hitting all time highs on Dow and SP500, and we can see the same phenomenon among economists working. In both cases, we saw economists over-estimate the effect of negative events and totally underestimate the effects of anything positive that could be taken from these two political decisions. To be honest, I was guilty of this on Trump. I thought he would win, but I did not expect there to be such strong risk on behaviour in bonds and equities. Conversely, we saw the opposite occur with the 2008 financial crisis. There were probably mutterings of ‘it’s housing, how can that go wrong’? Well in this case, the negatives were discounted totally. Part of this was due to ratings agencies providing smoke and mirrors to the actual situation, and part of this was due to the belief that if anything did go wrong, it would be so staggeringly bad that it just… couldn’t happen.
We also have the issue of data being provided sometimes 3 months too late (inflation forecasts for example). Economies are sensitive ecosystems. Supply and demand shocks can occur and change things very quickly during those periods. However, this is where I feel a more market analyst based approach has to be taken by economists rather than simply always adhering to macroeconomic models – humans aren’t rational beings all the time in relation to economics shocks, and the data lags don’t always reflect this. For example, I found it strange that the BoE cut rates by 25 BP back in August. You could say it was because they were trying to be accomodative, but then you have Andy Haldane coming out with statements that there are inflation risks, when we all know that monetary policy takes 12 months to take effect (however I think that just shows the Bank’s lack of forecasting ability and we go back in circles again).
One thing that I think that certain economists are really understating is the effect that China blowing up will have. Balls on the line, January 2018 that credit bubble will go boom (I can edit this if it happens in Feb).
David Belle FX 