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Forecasting econometrics

from Lars Syll

411e9aO5PCL._SY344_BO1,204,203,200_There have been over four decades of econometric research on business cycles … The formalization has undeniably improved the scientific strength of business cycle measures …

But the significance of the formalization becomes more difficult to identify when it is assessed from the applied perspective, especially when the success rate in ex-ante forecasts of recessions is used as a key criterion. The fact that the onset of the 2008 financial-crisis-triggered recession was predicted by only a few ‘Wise Owls’ … while missed by regular forecasters armed with various models serves us as the latest warning that the efficiency of the formalization might be far from optimal. Remarkably, not only has the performance of time-series data-driven econometric models been off the track this time, so has that of the whole bunch of theory-rich macro dynamic models developed in the wake of the rational expectations movement, which derived its fame mainly from exploiting the forecast failures of the macro-econometric models of the mid-1970s recession.

The limits of econometric forecasting has, as noted by Qin, been critically pointed out many times before.

Trygve Haavelmo — with the completion (in 1958) of the twenty-fifth volume of Econometrica — assessed the the role of econometrics in the advancement of economics, and although mainly positive of the “repair work” and “clearing-up work” done, Haavelmo also found some grounds for despair:

We have found certain general principles which would seem to make good sense. Essentially, these principles are based on the reasonable idea that, if an economic model is in fact “correct” or “true,” we can say something a priori about the way in which the data emerging from it must behave. We can say something, a priori, about whether it is theoretically possible to estimate the parameters involved. And we can decide, a priori, what the proper estimation procedure should be … But the concrete results of these efforts have often been a seemingly lower degree of accuracy of the would-be economic laws (i.e., larger residuals), or coefficients that seem a priori less reasonable than those obtained by using cruder or clearly inconsistent methods.

Haavelmo-intro-2-125397_630x210There is the possibility that the more stringent methods we have been striving to develop have actually opened our eyes to recognize a plain fact: viz., that the “laws” of economics are not very accurate in the sense of a close fit, and that we have been living in a dream-world of large but somewhat superficial or spurious correlations.

And as the quote below shows, even Ragnar Frisch shared some of Haavelmo’s — and Keynes’s — doubts on the applicability of econometrics:

sp9997db.hovedspalteI have personally always been skeptical of the possibility of making macroeconomic predictions about the development that will follow on the basis of given initial conditions … I have believed that the analytical work will give higher yields – now and in the near future – if they become applied in macroeconomic decision models where the line of thought is the following: “If this or that policy is made, and these conditions are met in the period under consideration, probably a tendency to go in this or that direction is created”.

Ragnar Frisch

Maintaining that economics is a science in the “true knowledge” business, I remain a skeptic of the pretences and aspirations of econometrics. So far, I cannot really see that it has yielded very much in terms of relevant, interesting economic knowledge. And, more specifically,  when it comes to forecasting activities, the results have been bleak indeed.

Firmly stuck in an empiricist tradition, econometrics is only concerned with the measurable aspects of reality, But there is always the possibility that there are other variables – of vital importance and although perhaps unobservable and non-additive not necessarily epistemologically inaccessible – that were not considered for the model. Those who were can hence never be guaranteed to be more than potential causes, and not real causes.

A perusal of the leading econom(etr)ic journals shows that most econometricians still concentrate on fixed parameter models and that parameter-values estimated in specific spatio-temporal contexts are presupposed to be exportable to totally different contexts. To warrant this assumption one, however, has to convincingly establish that the targeted acting causes are stable and invariant so that they maintain their parametric status after the bridging. The endemic lack of predictive success of the econometric project indicates that this hope of finding fixed parameters is a hope for which there really is no other ground than hope itself.

When causal mechanisms operate in real world social target systems they only do it in ever-changing and unstable combinations where the whole is more than a mechanical sum of parts. If economic regularities obtain they do it (as a rule) only because we engineered them for that purpose. Outside man-made “nomological machines” they are rare, or even non-existant. Unfortunately that also makes most of the achievements of econometric forecasting rather useless.

  1. January 15, 2016 at 6:49 pm

    “econometric forecasting” is what it is, a forecast of a future event..Any forecast of a future event is foolish and is made by a fool, if by chance the forecast is correct, the forecaster is justaluckyfool albeit still a fool. Shouldn’t all “economic forecasts have the disclosure-“Past performance does not guarantee future results.”

  2. BC
    January 15, 2016 at 10:49 pm

    Here’s my non-econometric forecast for the US economy, FWIW:

    The 4- and 6-qtr. average annualized growth rate for real GDP will be no faster than -0.5% to 0%, i.e., a recession.

    Profits to GDP will decline by an equivalent of 5-6%, prompting the Fed to print AT LEAST $2 trillion more to its balance in order to fund deficits/GDP to prevent nominal GDP per capita from decelerating to 0% or negative in 2016-18.

    The Fed’s balance sheet will reach 70% of bank loans (not counting charge-offs and run-offs, which could result in the Fed’s balance sheet reaching near 100% equivalent of bank loans) and 35% of GDP or higher.

    US housing prices will fall another 20% or so (much more in the bubbliest areas, especially high-end, buy-up houses) by the end of the decade. Houses bought since 2011-12 with less than 20% down will be underwater in the years ahead and result in Freddie, Fannie, and Ginnie being bailed out yet again.

    The U rate during the imminent recession could rise back to the highs of the previous recession, but not likely as peak Boomers exit the labor force en masse, resulting in the LFPR falling to 60% or below as has occurred in Japan. Rather than a U rate of 10%, we’ll more likely see 7-8% but with U-6 back to 17-18%.

    The overwhelming share of the incremental deficit spending during the next recession will be in the form of no-multiplier income support payments and making up the shortfall in SS and Medicare receipts, including food stamps, unemployment, SSI, SSDI, housing vouchers, etc. The large size of the deficits/GDP will preclude any “stimulus” for infrastructure, and any further imperial military commitments will constrain domestic infrastructure spending that much more.

    The 10-year yield could fall to 1% or below.

    The broad equity market is set up for another big bear market of as much as 50-60%.

    PPI finished goods prices and wages imply no acceleration of CPI, and perhaps the persistence of periodic 0% inflation or deflation.

    The post-2007 average trend rate of US nominal GDP will decelerate from 2.6% to below 2%, with the per capita rate at or below 1%.

    The price of oil will average in the $20s-$30s for the foreseeable future.

    And so it goes . . .

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