Why didn’t economists predict the crisis?

Raghu Rajan nails it:

I would argue that three factors largely explain our collective failure: specialization, the difficulty of forecasting, and the disengagement of much of the profession from the real world.

Read the whole thing, hat tip to Mark Thoma.

Comments

Isn't "the difficulty of forecasting" sort of begging the question?

Well if all of them or a large subset had been predicting the crisis then it wouldn't have been as large a crisis because prices might not have gotten so far from equilibrium. It almost seems like you can make an a priori claim that the market based crises that economists miss will be larger than the ones that some are able to forecast.

When I hear economists talk about this or that science being 'settled science' (what is that anyway?) and that a skeptical questioning of the scientific consensus (an oxymoron) being a lack of respect for science I think about the how many thousands of economists and financiers working on one problem and getting it wrong versus the 10 or so scientists working on each of these 'settled science' questions.

The majority of the profession is not scientific at all. The fed is their deity. Monetary creationism is the miracle from which all good things come and questioning this dogma is blasphemy.

The economist who did question and had a lack of faith are excommunicated, their forecast are not even acknowledged.

Because was making a list of Austrians who predicted the crisis.

The other people can make their own list.

here's Dean Baker's list:

Dean Baker

efficient market hypothesis of course.

what use is it - at least to market participants - to know a crisis is coming if you don't know when it will happen? show me anyone who can predict the economies direction WITH A TIME FRAME and i'll worship them.

Probably for the same reasons astrologists and manicurists missed it.

Even to this day most economists don't consider debt a vital part of their forecast. Of course, you're going to get it wrong when, as Steve Keen has shown, debt levels correlate highly with levels of unemployment etc.

So let's start to talk about the coming "subprime crisis", Chinese edition. But we should hurry up for it will be happening in a few months…

Those Austrians are so insular that we need to kick them out of mainstream economics.

The economist who made correct forecasts were racists, end of discussion. We need more debt to save us, that is all we need to know.

Given the continued favor of huge and ever increasing debt, and elite manipulation of the economy, it appears the economists do not even know about the past crisis.

Perhaps this is a natural effect of democratic bureaucracy, which government by Science is unable to overrule.

I found Pr. Rajan's analysis a little disappointing; too many holes. Or perhaps a cynic could poke holes in it. For example, he says it is hard to predict turning points but then goes on to conclude that economists were not paying attention. If they were paying attention, would they have predicted the turning points. Many other similar contradictions in the piece.

My Hayek reading predicted the crisis.

The problem is the problem Hayek identified -- your profession is dominated by fake science.

You give us fraudulent fake science, and we are suppose to wonder why you guys keep crapping up the economy -- and you are always surprised by what happens next?

BIS chief economist William White and his staff predicted the crisis.

Why the hell won't academic economists admit when they've been schooled by one of their peers working in the real world?

I would put cowardice way up there as a plausible factor. Predicting that next year is going to be a lot like this year never got anyone laughed out of the profession. This style of prognostication is mostly correct, and when you are wrong you will always have lots of company. The Bakers, Rajans, Roubinis, and Schillers of the profession tend to annoy their peers by disturbing this cozy little consensus, and even when they are correct on the merits, they risk being wrong in the actual event.

Edward Prescott predicted the Global Financial Opportunity for me; and the next one. Being ready for it is the difficult part; but many people manage it.

"(They all just got lucky.)"

And that's entirely possible. It's a human failing to think that any prediction which becomes true must be because the predictor had special knowledge. If anyone who thinks they predicted the housing bubble wants to actually make predictions in a scientific fashion they will:

1/ Make quantifiable rather than qualifiable predictions. "There will be a crisis" is not good, "U.S. unemployment will hit 10%" is.

2/ Make predictions which are specific. "U.S. unemployment will hit 10%" is no good, "U.S. U-3 unemployment published by the US Bureau of Labor Statistics etc. will hit 10%" is.

3/ Make predictions which include the specific time in which it comes true. "U.S. U-3 unemployment etc. will hit 10%" is not good, "U.S. U-3 unemployment etc. will hit 10% some time in 2012" or even "U.S. U-3 unemployment will hit 10% at some point in the future" are.

4/ Make predictions publicly and clearly stated as predictions on which you will be judged. Lots of people make lots of predictions, and everyone remembers the predictions he or she got right, and forgets the ones he or she didn't. It's human nature. Many like to make contradictory predictions at different times, and then when one comes true, remember that one and forget about the others. If you really want to test your predictive abilities, then be very clear that you are making a prediction when you are making it.

5/ Let the probability of your prediction be scored when it is made. "American U-3 unemployment will hit 10% some time in the future" is very likely. "American U-3 unemployment will hit 10% some time in 2012" is less likely. Making predictions that are likely, which then come true, is not so great.

As someone who bragged here about calling it, lots of people, including a non-trivial number of economists, figured out that we were in a housing bubble before it peaked, especially after Shiller came out with the second edition of his Irrational Exuberance in 2005, whose newly added Chap. 2 laid out the evidence for it pretty unequivocally. However, calling the peak of that was very difficult and few did (and I never tried).

Once it peaked and began going down, we were in a different ball game, with some immediately calling for a recession based on declining construction, notably Baker and Roubini, although both also warned about more serious financial problems related to the bubble declining. Others such as me also got into the game at this time or later. Many people called this or that piece of it, but almost nobody got every single piece of it, including the timing of all the critical moments, fully right.

I think that Rajan's final argument about a lot of people simply not paying attention, along with a lot of complacency, is a major explanation for why so many were not up on what was going down.

I would also add the propensity of some to call those who predicted it "credit snobs".

Ha-ha. Economist failing to identify the reason for economists' utter failure. Clueless^2.

mulp -- read the work of Ed Leamer.

Again, an economic outside of the ancient regime controlling elite macroeconomics in America.

I must have read a hundred different columnists comparing the economy to a "sick patient" who is in the "ICU" and need of "strong medicine" over the last three years. Now we have Raghu Rajan comparing economists to specialist physicians. Please. This analogy is silly from the get go. A specialist physician is MUCH more likely to diagnose and correctly treat an exotic disease (mountains of research to back this up). And more to the point: is the largest credit/housing bubble in history really all that exotic? It was quite easy for me to spot it looking at rather simple metrics like house price to income levels, house to rent ratios, junk bond spreads, leverage ratios etc... Only someone locked into some modeling cage would have not spotted this bubble and the crisis it spawned from miles away.

Stop already with these economics:medicine analogies. As onetime student of economics and now specialist physician I resent you all trying to piggyback on our hard earned reputations. Please go back and resume comparing yourselves to physicists.

Doc, all economists who aren't part of the tiny, inbred community of top 20 dept. macroeconomists simply don't count -- they have zero standing. For all purposes of the profession guild of Ph.D. certifying macroeconomists, they simply don't exist.

Doc writes,

"Um, many economists did predict the crisis."

Lou -- these guys DID make forecasts, they repeatedly said everything was ok, and they argued against those saying other wise.

And most of them are paid or published at one time or another by the Federal Reserve of the Federal Government -- and this stuff takes place for a purpose. Their "science" has very practical application constantly in the operation of the U.S. economy.

Lou writes,

"I don't think the question is why academic economists didn't forecast the crisis. Obviously, because they are not in the business of forecasting near-term macroeconomic developments."

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