The Bank of England is unlikely to successfully predict the next economic crisis
Successfully predicting the next financial crisis is unlikely, a Bank of England official has admitted, leading to questions about mainstream economic forecasting and raising a further challenge to existing paradigms that depend upon modelling and running economies mechanistically. Do we need to a new kind of economics? Martin Sandbu undoubtedly asked the right question in his Financial Times book review of The Econocracy, but his defence of neoclassical economics isn’t likely to satisfy many of those who are looking for answers.
“We are probably not going to forecast the next financial crisis, or forecast the next recession. Our models are just not that good”, the admission by Gertjan Vlieghe, who is a monetary policy committee member at the Bank of England, when addressing a group of MPs was surprising for its starkness, even if a little late in delivering an insight that had been publicly played out over the course of the previous decade.
Coming on the back of the Bank of England’s chief economist, Andrew Haldane, admitting that his profession needed to adapt after the series of pre and post 2008 crash prediction errors, and misjudgments about the impact of the Brexit vote, Vlieghe argued that demands from MPs for economic forecasts with a higher degree of certainty were misguided.
It is “irrational behaviour” in the modern era that has caused the failure of economic models according to Haldane, who described the unforeseen collapse of the Lehman Brothers as the economics’ profession’s “Michael Fish moment” (the BBC weather forecaster who in 1987 famously dismissed the possibility of a hurricane, which would devastate large parts of the south of England). Comparing the current challenges to those that led to the creation of modern day macro-economics in the 1930s, he argued that a similar re-birth of economics is possible now.
Comparisons to weather forecasting, where it is possible to plot a five decade long upward trajectory can only go so far. A similar trend cannot be painted in economics, and FiveThirtyEight founder and prediction expert Nate Silver argues in Why So Many Predictions Fail that too much attention is given to measuring and predicting noise, rather than developing clarity around the key “signals”, which really impact the global economy’s trajectory.
Conversations about the future of economics need to go beyond the tweaking of existing models. Nick Hanauer and Eric Liu have argued extensively for a transition from a 19th century machine mindset to embracing a 21st century “Gardenbrain”:
“It turns out that advanced economies in particular, aren’t simple, predictable and efficient like machines. They are complex, adaptive and effective like ecosystems. They are subject to the same feedback loops and evolutionary forces.”
Viewing and measuring a complex adaptive system based economy purely on a limited spectrum inputs and outputs is hard enough, and it is made close to impossible when critical factors are externalised, including the role of energy, materials, land and environmental impacts. Throw in the treatment of money purely as a medium of exchange, and it should come as no surprise that the old formula of success, built upon the treatment of finite resources as if they were infinite, a reliance upon ever increasing demand and plentiful access to free credit has fallen apart.
Regardless of whether Sandbu’s defence of neoclassical economic theory is ultimately accepted or not, there’s no question that some significant re-thinking about how we operate and measure our economies is required, and one definite part of that re-think must be around consumption and the way in which materials and energy are cycled through the economy.