Sunday, February 6, 2011

Prediction failure

Raghu Rajan's take on economists' failure to predict the crisis:

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.

... Because the profession rewards only careful, well-supported, but necessarily narrow analysis, few economists try to span sub-fields.

Even if they did, they would shy away from forecasting. The main advantage that academic economists’ have over professional forecasters may be their greater awareness of established relationships between factors. What is hardest to forecast, though, are turning points – when the old relationships break down. While there may be some factors that signal turning points – a run-up in short-term leverage and asset prices, for example, often presages a bust – they are not infallible predictors of trouble to come.

The meager professional rewards for breadth, coupled with the inaccuracy and reputational risk associated with forecasting, leads to disengagement for most academics. And it may well be that academic economists have little to say about short-term economic movements, so that forecasting, with all its errors, is best left to professional forecasters.

My thoughts were here. However, I had some other ones as well that others have already pointed out:

If I predict something bad will happen and if I take steps to prevent it from happening does this mean that my prediction was wrong? For instance, a fortune teller informs me that I will be in an auto crash today and as a consequence of the warning, I avoid going out of the house. Does this mean that the fortune teller was wrong?

If economists have predicted nine of the last five recessions does this mean that due to feedback effects, homo economicus have taken step to avoid four of them? If an engineer predicts that 30 percent of bridges in this country will collapse in the next 5 years and the government took steps to prevent it does this mean that the engineer was wrong?

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