Working Papers

‘Really big, bad things tend to be surprises’

An article on how the economics profession is reflecting on the GFC:

Robert Lucas, an economist and Nobel laureate at the University of Chicago and a champion of the rationality of markets, doesn’t see much fundamental change coming out of the crisis, either. What it has reminded us of, he argues, is simply the impossibility of seeing these events in advance.

“I don’t know anybody involved who thought he could predict these turning points. Do macroeconomists know as much as we thought we did?” he asks. “Of course not.”

By this logic, the problem isn’t how economists see the world so much as it is what we expect of economics.

Laurence Ball, an economist at Johns Hopkins, makes a similar point. “Nobody ever sees anything coming,” he says. “Nobody saw stagflation coming, nobody saw the Great Depression coming, nobody saw Pearl Harbor or 9/11 coming. Really big, bad things tend to be surprises.”

Even Monty Python understood this basic rational expectations insight: ‘Nobody expects the Spanish Inquisition!’


posted on 22 December 2008 by skirchner in Economics, Financial Markets

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Nobody saw it coming?  Really?!

Have you actually watched this video?  Schiff so right its scary!

Now I realise financial doomsayers like Schiff have predicted 10 of the last 3 recessions, but at least they identified the problems in advance, and accurately predicted the likely consequences.

Stephen, do you want me to dig up some old posts of yours from the 2005-2006 period?  They make interesting reading :)

Posted by .(JavaScript must be enabled to view this email address)  on  12/24  at  03:38 AM

So far I count two tactics being employed by the mainstream to explain their total failure to predict the crisis.

Tactic one is to declare that no one expected it. (your tactic). 

Tactic two, employed by Tyler Cowen and others, is to attribute the crisis to real shocks ex post that were totally unpredictable and lets the Fed off the hook ( as opposed to a policy-induced crisis). 

But you don’t have to be a ‘fever swamp’ Austrian to acknowledge the micro/ sectoral imbalances that can fester due to interest rate distortions even during relative price stability (and even when money is endogenous).

Or, if Institutionalism is your bag, give an appropriate hat tip to the Minsky crowd .

But at least recognize that many economists predicted the crisis in remarkable detail.

Mainstream has some ‘plaining to do.

Posted by .(JavaScript must be enabled to view this email address)  on  12/29  at  03:17 AM

Many of those who supposedly predicted these events work from radically different models, ranging from ABCT to Minsky to no model at all.  These models cannot all be right, unless they are catch all theories that are sufficiently flexible to explain everything - and therefore nothing.

Posted by skirchner  on  12/30  at  01:35 AM

Good point- Many of those who got it right used either an ABCT or Minsky model, which as you say are “radically different models”.  But maybe not so different.

They both are heterodox schools, operating outside the mainstream, and highly critical of the neoclassical models used by Wall Street and Washington.  Each had a critical eye towards the destabilizing effect of stability.  Minskyans warned of Ponzi finance, Austrians warned not to be fooled by stability in price indices, like CPI.  Money is not neutral in either model, in either the long or short term, and they are each skeptical of Neoclassical risk models, used extensively on Wall Street, preferring the concept of Keynesian/ Knightian uncertainty, and so perhaps were not taken in by a false sense of security. 

Meanwhile, modern macro of the new keynesian/new classical variety are hardwired to accept rational expectations and therefore less likely to see policy-induced danger around the corner.

Besides it’s tough for the mainstream to be too critical of the system they themselves built.

Posted by .(JavaScript must be enabled to view this email address)  on  12/30  at  03:47 AM

As I understand it, there are similarities between ABCT and Minsky (excess credit creation, speculative euphoria, followed by a credit crunch) its just that the Austrians blame it all on central banks, whereas Minsky says the financial markets are inherently unstable and it would happen anyway (with or without “Easy Al”).

Schiff, Roubini, Faber, Schiller, Keen ... all identified excess credit and asset bubbles as a serious problem, and accurately predicted a collapse in asset prices and a credit crunch as the inevitable consequence.

If you look back on what other economists were saying about house prices during 2005-2007 period, you could find some really embarassing stuff.  UK house prices are falling at more than 2 percent a month, and accelerating.

Posted by .(JavaScript must be enabled to view this email address)  on  12/30  at  06:25 AM

You could equally say there are similarities between New Keynesian and monetarism.  It is not enough to have a descriptive account of what a business cycle looks like.  We already know that.  What is needed is some idea of underlying causality based on sound methodological foundations.

To say that falling house prices establish the existence of a ‘bubble’ is little more than a tautology and does not invalidate what Stephen Nickell was saying in 2006.

The only people who should be embarrassed are those articulating discredited macro theories from the 1930s.

Posted by skirchner  on  12/30  at  10:18 PM

An underlying causality was identified using a specific methodology.  You do not agree with their explanations and you reject their methodology despite their accurate forecasts.  OK.  I just wish the mainstream came under harsher criticism for getting it totally wrong despite (or because of) the elegance of their mathematical models.
What I like about this blog is that you seem to have done the work and studied the theories before rejecting them which is more than I can say about other econo-bloggers who seem to think they know enough to dismiss Austrian economics, for example, because they read Tyler Cowan’s blog.

Posted by .(JavaScript must be enabled to view this email address)  on  12/31  at  02:34 AM

A rational expectations model would maintain that the crisis is unpredictable, so the failure to foresee the crisis is in fact entirely consistent with such a model (which was the point of this post)!

A forecast that says “a downturn is coming” will be randomly correct every five to seven years, which is about how long most of the doomsters have been making their predictions.

Tyler Cowen’s book “Risk and Business Cycles: New and Old Austrian Perspectives” is a good critique of ABCT from someone otherwise sympathetic Austrian perspective.

Posted by skirchner  on  12/31  at  02:53 AM

Most Austrians and Post Keynesians fundamentally reject RE; most mainstream reject those who reject RE.  It’s a dead end, despite Tyler’s efforts.

Posted by .(JavaScript must be enabled to view this email address)  on  12/31  at  04:15 AM

A forecast that says “a downturn is coming” will be randomly correct every five to seven years, which is about how long most of the doomsters have been making their predictions.

Fair call.

However, the issues the doomsters warned us about 2-3 years ago turned out to be very serious indeed, whereas most economists (yourself included) claimed at the time there was nothing to worry about (“consenting adults” and all that).

The doomsters may have got the timing wrong, but they didn’t get everything wrong.

At least Peter Martin has the courage to admit he was wrong.

Posted by .(JavaScript must be enabled to view this email address)  on  01/01  at  10:39 AM

The primary problem with 99% of economists is they have very little intellectual depth.

They have no idea of the origins of their discipline. They don’t question the tools they are taught to use (e.g. mathematics) in an epistemological sense.

They have only a superficial historical knowledge of the matters on which they express opinions. So, even supposedly free-market economists will be led into saying that “We need government to guarantee bank deposits” or “A small stimulus package is needed” or “Interest rates should be cut during a recession”, without having done conducted a thorough survey of every single historical incident relevant to their policy conclusion.

The Austrians do this kind of painstaking historical analysis, fitting theory to the facts. They regularly write treatises and go beyond the standard textbook/journal article mathematical models. Mainstream economists don’t, and hence possess a very shallow understanding of economics as a social science; they are more like 3rd rate mathematicians than economists (to paraphrase Rothbard).

The Great Depression of the 1930s, the breakdown of the Bretton Woods system and the current financial crisis - all these were foreseen.

Posted by Sukrit Sabhlok  on  01/01  at  11:49 AM

Sukrit, the Austrian School also argues economics is not a predictive science, so the claims of the pseudo-Austrians to have “foreseen” anything violates their own methodological precepts.

Posted by skirchner  on  01/01  at  10:09 PM


You make Austrians sound like a branch of RE.  That’s Tyler Cowan, not Mises, definitely not Menger.

With regard to the statement “not a predictive science” and methodogical precepts, Mises was referring to the Austrian theory of value, interest, capital and money, not ABCT. 

ABCT is not Austrian Theory proper (most bloggers don’t know this). It’s an ANALYSIS (unfortunately named a theory by Mises himself) of how government intervention in money create booms and busts that deviate from Austrian theory. Using this ABCT analysis, Mises himself forsaw the coming Great Depression. Was he a pseudo-Austrian too?

Posted by .(JavaScript must be enabled to view this email address)  on  01/02  at  12:55 AM

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