Folly from Olly. The disasterous quality of the economic predictions of the European Commission

From Jesse Frederik (guest post)

EU and ECB macro-economic policy is based upon predictions of economic growth. This means that they have to use an economic model which is fit for the task. But the model used by the European Union and defended by top-bureaucrat Olly Rehn is clearly wrong. As it does not fit the facts: it’s nine month ahead predictions (made in the spring of the year t-1) were wrong by a whopping between 6 and 8%-point margin of GDP. Not once – but four times in a stretch (graph).

The dismal quality of the ECB projections is a disaster which is wrecking Europe and which endangers the future of the Euro (and compromises the status of economics as a scientific discipline, M.K.). And, as they should have known better it’s an outright criminal. The main culprit is the low level of the ‘multiplier’ (about 0,5) in the models. The models are based upon the mistaken assumption that, when you lower pensions, fire teachers and insult entire countries as being irresponsible and corrupt, people will start to spend more instead of less, as their income dwindles but their confidence increases, therewith offsetting about 50% of the government cuts.

And no, we’re not overstating this case.
* It’s well known that the IMF calculated that in times of a severe crisis multipliers are quite large and often even larger than 1.
* And even the ECB has calculated that multipliers are quite a bit larger than those used by the EU and often even larger than 1
* And some high status economists have been arguing for quite some time now as well as extremely loud that multipliers are – as large as taught to students in economics 101, i.e. often larger than 1 – their predictions were much less of the mark than those of the EU.

I didn’t read it, yet, but it seems that the European Commission has written a report which defends the idea that business and consumer confidence in countries in Greece and Spain is not low because of the cuts but because of the behaviour of these irresponsible capital markets. Reminds me of a Goethe quote: “Intelligent people are sharpest when they are wrong”.

(And yes, I dear to take a large bet with mister Rehn about the quality of the 2013 predictions, M.K.)