Thursday, February 05, 2009

Predicting Earthquakes

by Andrew Gillen

Today’s Inside Higher Ed offers some evidence that the predictions I made back in April are coming true.

Fortunately, three things make it unlikely that I’ll let this go to my head. First, in the study, I said that
readers should bear in mind that economists who try to make predictions tend to make the long-range forecasting of weathermen look good in comparison.
This was an admission that there are lots of other factors at work as well. Second, I’m in the middle of reading The Halo Effect. And third, the general failure of my profession to predict the economic meltdown, and the utter confusion about what to do about it.

This last point has been on my mind a lot lately. The profession has come in for some deserved criticism, but I would now like to offer a partial defense. Basically, people have unrealistic expectations of economists.

To illustrate, let me stick with my weather related theme from above. I want to contrast three types of events. The first group concerns regular weather patterns, like summer Monsoons. Because these are reoccurring, theories on them lend themselves to quick and repeated testing, and we would expect for our understanding of them to be fairly good. The second group concerns more detailed information on regular patterns, such as the rain that will fall in September. These are subject to many other factors, so we can only really come up with a range around which we are reasonably confident. The last group concerns theories about events that are rare and/or difficult to test. Predicting earthquakes comes to mind. While we are pretty sure what causes earthquakes, it’s very difficult to use that information to predict earthquakes with any precision.

Now, back to economics. Recessions are a fairly regular occurrence, like monsoons, and as such --patterns have been identified that typically can predict recessions. It’s not perfect (sometimes recessions are predicted and don’t happen), but it’s pretty good. The severity or duration of recessions is like predicting rainfall – we can make some guesses, but can really only come up with a range where we are reasonably confident the value will end up. Depressions are the earthquakes of economics. We can really only (try to) explain them afterwards, and those explanations are not very useful in predicting the next one.

And because Depressions are so rare, we don’t really know what works to get out of one. We’ve only got one observation to work with (domestically anyway), so we're left with a bunch of non-falsifiable conjectures. It’s like trying to draw the correct line when you’re only given one point.

As a Congressional Budget Office (headed by Obama appointee Douglas Emlendorf) report released yesterday notes:
The macroeconomic impacts of any economic stimulus program are very uncertain. Economic theories differ in their predictions about the effectiveness of stimulus. Furthermore, large fiscal stimulus is rarely attempted, so it is difficult to distinguish among alternative estimates of how large the macroeconomic effects would be. For those reasons, some economists remain skeptical that there would be any significant effects, while others expect very large ones.
Hence the spectacle of very smart economists accusing each other of not knowing anything. I think Will Wilkinson gets it right:
what doesn’t arise in my mind is a sense that some of these guys really know what they’re talking about while some of them are idiots. What arises in my mind is the strong suspicion that... on the questions that are provoking intramural trashtalk, there is no science.
What's basically happening is that folks who can predict monsoons, and come up with good ranges for rain fall in September, are now being asked to predict earthquakes.

There are really two takeaways from this. First, don’t listen to economists who say they can predict earthquakes. Even if they studied the last one, and drew all the right conclusions, those lessons might not apply to the next one. Second, don’t expect economists to predict, or know how to get out of, earthquakes.

No comments: