the unwitting economist

Economic forecasting, when it matters, is a highly difficult task.  As the economic cycle (which started at the trough of the global financial crisis) extends to be amongst the longest in history, we continue to see economists trying to gain notoriety by being the first to presage when the next downturn will be.  They should know better, but don’t.  When recessions (a downturn from the usual growth environment) have in fact occurred historically, they were mostly caught off-guard.  Particularly in the 2008 recession, which was the worst since the early 20^th century Great Depression.  In this article we’ll have some discussion of this, as well as insight into the small groups of people who do correctly predict and profit from recessions.

We start with a fresh social media thread where The Wall Street Journal surveyed private sector economists about when they expected the next recession to be.  ½ said in 2020.  The issue with this endeavor is such private-sector surveys have a perfectly poor history:

* in 2012 economists saw US recession coming in 2012

* in 2015 economists saw US recession coming in 2015

* in 2016 economists saw US recession coming in 2017 (if Trump wins)

* in 2018 economists saw US recession coming in 2019

This leads us back to the 2008 recession, which I helped clean up as the head for the TARP analytics team (ultimately advising Paul Volcker and others).  Alan Greenspan -once dubbed "Maestro"- later said that everyone missed the warning signs of this crisis.  “Everyone” being the small number of people he surrounded himself by for advice.  Institutional minds.  Minds with correlated group think.  Of course when pressed, he did later concede a small group (and of not negligible number) did get it right, though even then mostly by luck.  A couple handful he said.  But he clearly doesn’t know about this.

Let’s outline this more fully.  There are four distinct people types who correctly profited from that downturn.  Group (a) and (b) differ, and each have two versions:

 * a-1. those who generally knew something was wrong (but unsure what), and then got lucky about timing

 * a-2. those who generally know "when" something is wrong, but never sure what specifically each time

 * b-1. those who knew something specific was wrong in one case, and then got lucky this recession was about that

 * b-2. those who always know "what specific" is wrong, and the recession is each time about that

Groups (a) and (b) are different.  Alan Greenspan joins most in not knowing that there’s a difference, let alone the existence of a difference.  Further, Alan Greenspan believed at first no one existed with pre-recession knowledge, since none of his gurus [who he feels include those in groups (a2) and (b2) since again he doesn’t know there is a distinction between those two] saw the recession.  But when pressed suggested people such as Peter Schiff and Michael Burry are in the group of lucky (b1) people.  While he has a small number of friends such as John Paulson in the subset group of skilled (b2) people.  In fact people who work at the Federal Reserve are not in any of the four groups above.  In other words, they never could predict recessions to begin with.  And those who could predict recession do not go on to advise the Federal Reserve.  We’re all blind to this knowledge and information gap.

Accurately predicting recessions means that you’ll know what will happen and when.  Not knowing both (as most do not), proffers no meaningful insight over a lay person.  In fact it could lead to poor decision making, such as submitting to these economist surveys, or relying on this faulted data and poor insight in order to guide our best personal decisions.

Also consider who you are and your own unique set of concerns.  It's naïve to believe that all relevant probability math is a one-size-fits-all sport.  How you factor all of your personal interests and life considerations matters.  Take this poll below.  Reflecting on how you see through things will help you better manage risk.

which are you?
a. you can at times be universally fearful, & unsure why
b. you are perpetually fearful of many pointless things
c. you are at times unnecessarily fearful of something very specific
d. you may always be fearful of something specific, & those ‘things’ keep changing

— Statistical Ideas (@salilstatistics) March 17, 2019

Regardless, one should also always be diverse in the thinking you embrace.  For more consideration, please see this from a former colleague Larry Summers:

Larry Summers: "Critics hold out failure of economics profession to predict financial crisis... fails to acknowledge a central idea taught in finance: Market breaks are inherently unpredictable..."

If breakdowns are unpredictable, why still go on TV to predict them?
cc @nntaleb pic.twitter.com/bqsnJLABJQ

— Statistical Ideas (@salilstatistics) January 26, 2019

Also a reminder basic statistics concepts are available in my probability theory book, on sale at Amazon (best seller in 2015 & 2016).