Data Delusion

Markets are slaves to ‘fake’ data-a statistic is not a fact!

If you think forecasting is a humbling experience have a thought for the poor statistician trying to collect accurate economic data. The truth is forecasters struggle to forecast sunrise and the statisticians can only provide guestimates. Both forecasts and data are subject to regular revisions. In layman’s terms they are invariably wrong.

So what has gone wrong with the data? Economists and the media have presented statistics as fact. They are not, but their religious attention to the monthly data releases creates a false sense of confidence in their accuracy. They counter this by stating they are merely satisfying demand. GDP, Inflation, Current account, Unemployment are artistic interpretations framed by international convention, but their outcomes can topple a government.

The major issue is that the world has changed. The rapid structural changes, led by technology, is poorly captured in practices designed over 60 years ago when the UK and the West was largely manufacturing based, as opposed to the current dominant service sector.

Charlie Bean (ex BoE, MPC) concluded that the current statistics are antiquated (Independent Review of UK economic statistic: final report, 2016). The digital revolution has given rise to new ways of exchanging and providing services and made it far harder to measure accurately economic output. In the past many of these services would be paid for and captured in GDP but now are free, albeit bundled with advertising. Ironically, GDP may actually fall while the quantity and quality of services are increasing. Moreover, companies such as Amazon, Skype and Google operate across national boundaries which make it difficult to allocate value added to particular countries. The versatility of modern technology has also spawned the rise of the self employed- about 15% of the UK workforce. This has confused the issue on many fronts not least measuring hours worked and labour productivity. Capital spending may in certain cases be underreported as consumer spending e.g. laptop, tablet and these businesses make better use of non-business assets. Traditional employment and income data will no longer capture the reality of the labour market. Income, traditionally paid by salary, has been understated as the self employed incorporate and receive proprietors’ income and/or dividends. Recognising this in September the UK Office for National Statistics (ONS) announced one of its largest revisions to the national accounts. As a result, real household disposable income grew 5.3% in 2015, not the 3.5% currently recorded and the savings ratio rose from 6.1% to 9.2%! What this ultimately means for the alarming Q1 2017 savings ratio, which was the lowest for 50 years at 1.75%, is problematic.

Bean suggests that if the digital economy was fully captured by official statistics, it could add between 0.3-0.75% to the growth rate of the UK economy.

This may not trouble you but another ONS study found that foreigners own more UK equities and corporate bonds than previously thought and an error in recording of dividends shows that there are more income outflows than previously thought. The effect of these changes will be for the 2015 current account to deteriorate from a deficit of £80bn to £98bn, nearly 1% of GDP.

Does it really matter? Yes. While the household sector might be in a slightly better position than thought the UK is increasingly dependent on foreign flows and on ‘the kindness of strangers’.

We have just received another data bombshell from the Office of Budget Responsibility (OBR, Forecast Evaluation Report, Oct. 2016). They are reducing their assumption for potential productivity growth over the next five years which would weaken the medium term outlook for public finances. The OBR describe the arithmetic divergence between their central forecasts and the subsequent outturns as ‘differences’ rather than ‘errors’ because when the forecast was made they were not in possession of sufficient information!

Given the litany of data  ‘failures’ you may well be wondering then how the UK Treasury came to the conclusion that ‘brexit’ would make us worse off in fifteen years’ time.

The problems with data accuracy are actually getting worse. It is not just a UK issue. US GDP is a case in point. Since 2010 75% of initial releases have been revised higher. A major part of the problem is that most economic data is survey based, at least for the initial releases.

Meyer, Mok and Sullivan (Household Surveys in Crisis,2015) examine the decline in quality of US household surveys. The overall message was that households are overburdened by surveys, leading to a decline in many measures of survey cooperation and quality. Indeed, they have become increasingly less likely to answer surveys at all. In one example they note that replies for the consumer expenditure survey dropped from over 85% in the early 1980s to only 65% in 2103. This is an important survey as it helps generate the weights used in consumer price inflation.

Households are reluctant to answer certain questions, especially details on income. To overcome missing data most surveys typically impute a response. When households do provide answers, they are less likely to be accurate. One way to test for measurement error is to link survey data for instance on welfare payments that households say they have received with administrative micro data on the amounts actually provided to each household. They show that survey measures of whether an individual receives income and of how much income is received from major transfer programs are both sharply biased downward, and this bias has risen over time.

Survey data becomes more problematical when surveys are voluntary. Selection bias and loss aversion can apply. Selection bias arises because there is an opportunity cost to participating in a survey, and so voluntary surveys will tend to attract only the more passionate participants in that particular field; the apathetic majority tend not to participate. With loss aversion people tend to apply a disproportionately larger weight to a loss than they apply to a gain. As a result people are likely to be more passionate about negative than positive opinions again skewing voluntary polls.

Even when a variable is seemingly well defined, such as the total number of people working at a particular time, in most cases it still has to be estimated, usually by sampling a fraction of the total population. Ensuring that this sample is representative is challenging in itself.

Markets like surveys as ostensibly forward looking indicators. The problem with surveys is that there has been a tendency for survey results to overreact to underlying economic data. This media obsession with incomplete or simply inaccurate data is a concern.

The brexit debate was framed by bogus forecasts and ‘antiquated’ data. This problem is not set to diminish as we proceed along the ‘fourth industrial revolution’. We don’t even know the margin of error. The Bank of England assume there is about 3-4% range of possible growth numbers around the official GDP data!

Commentators, politicians and economists need to educate the public of these data deficiencies and be cautious on policy response to numbers we do not understand or unable to compute with any certainty.

James Sharpe

October 15^th 2017

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The establishment still peddling half-truths on Great Crash

On the perceived 10^th anniversary of the financial crash the blame game is back in full swing. The players of the time are being wheeled out such as Darling (UK Chancellor),King (Bank of England Governor) and Peston (BBC Business Editor). From the outset the practice has been to deflect ‘blame’ from politicians, central banks and the regulators. Indeed, the BBC commentary, notably on the Today Programme, remains one dimensional and thin on analysis. Its focus on ‘greedy’ bankers has an air of hypocrisy after the recent salary disclosures. This article I hope will give a more balanced and thoughtful view.

Having been directly involved in many crises since the 1970s I am acutely aware that they can be triggered by both small and large events, but all require a gestation period where policy errors accumulate.

The origins of the ‘2007’ crisis can be seen from the 1980s with the sharp growth in banking assets and accelerated bank concentration which inevitably led to a reduction in trading counterparties, notably in derivatives. This process was partly driven by changing technology that allowed benefits from economies. of scale and the result of bank failures. The ending of US restrictions on interstate branching in the 1980s was a case in point and was prompted by the Texan bank sector collapse. In the UK, relaxation of controls through the Building Societies Act 1986 and relaxation of controls on banks’ balance sheet expansion around this time would also have far reaching consequences. In the US the Clinton Community Reinvestment Act which as Senator Gramm highlighted recently forced banks to make mortgage loans to borrowers that were riskier than normal loans and for many was the genesis of the US crisis.

We approached 2007 with as much thought of the Great Crash as the Edwardians had of the Great War. Complacent sentiments from the Irish Review could be replicated across the globe.

Irish Banking Review 2006

The Irish financial sector has continued to perform well since its participation in the Financial Sector Assessment Program (FSAP) in 2000. Financial institution profitability and capitalization are currently very strong, with Irish banking sector profits amongst the highest in Western Europe. Reflecting their good performance, the major Irish banks receive upper medium- to high-grade ratings from the international ratings agencies’.

 

The background to the 2007 crisis is usually subsumed by antipathy towards the banking sector. It was actually led by an explosion of credit, easy monetary policy, easy loan standards, a global savings glut and integrated international capital markets with macroeconomic policies that fuelled large capital flows, a boom in toxic financial innovations, risk control models which were simply wrong and of course greedy bankers who were led by their bonuses. A perfect storm or just a perfect excuse.

The perfect excuse in Europe was that that the crisis was ‘made in America’. Other countries were affected by financial contagion due to their greater exposure to securitized assets that were largely generated in the U.S. The reality, supported by numerous reports, is that for Iceland, Ireland and the UK their crises were essentially home grown. Indeed, warning signals, notably double digit growth of balance sheets were clear in advance and represented a failure on the part of regulators. In the case of the UK, mortgage lending was largely backed by short term funds while an unshackled Building Society sector, was managed by staff totally ill-equipped to deal with their new freedoms.

Liquidity is the basis for any market to operate effectively and this became the core of the problem for the financial sector as central banks were slow to act. Banks essentially fund their business through shareholders’ capital, retail deposits and interbank borrowings. Retail deposits are considered ideal because of their stability. In the years before the crisis loan growth had outstripped the growth in retail deposits. This ‘gap’ was made up with borrowings from other banks in the interbank market. By August 2007 for all practical purposes the global interbank market was closed. Quite simply the banks were not prepared to lend. The expected response in the UK was for the Bank of England to provide credit facilities. Institutions such as Northern Rock were vulnerable given their reliance on interbank funding. The lukewarm response from the Bank of England and BBC coverage (Peston leak on funding difficulty) prompted a run on the bank, despite a belated Government deposit guarantee. On February 22nd,2008 Northern Rock was nationalized with no compensation.

In 2008 funding difficulties for many UK financial institutions (exception HSBC with extensive Asian retail network) had become acute. On October 8th The UK Government and the BoE presented the bank rescue package. The BoE would provide short term funding (Special Liquidity Scheme) and capital injections from the Government (Bank Recapitalization Fund). RBS, Lloyds and HBOS agreed while Barclays raised funds from Qatar which is currently the subject of a criminal investigation. Lloyds returned to private ownership in 2017.

There is the opinion, echoed by Tim Congdon (Telegraph 2017), that the BoE fuelled this fiasco through their delays (and perceived unwillingness) in acting as lender of last resort.

Congdon quotes Bagehot (1873) warning that unless central banks acknowledged the need for such loans to counter a run, ‘our liability to crises and our terror at crises will always be greater than they otherwise would be’.

The US dollar is the global reserve currency and the pre-eminent funding currency. Here the normal interbank function had ceased to operate (evidenced by a sharp rise in short term borrowing rates). In December 2007 the US Federal Reserve enabled foreign central banks to deliver US dollar funding to institutions in their jurisdiction via dollar swap facilities. This was a key initiative in saving the financial system from Armageddon. At the program’s peak in December 2008, swaps outstanding were over USD580bn.

The role of regulators rarely gets an airing in the media despite subsequent reports that indicate the regulatory authorities failed to enforce the powers they had. Special Investigative Report of the Icelandic Parliament (2010, Chapter 21, pp. 98- 104) note supervisors being understaffed, excessively meek in pursuing corrective actions, and willing to tolerate flagrantly risky behavior with little or no response. These are common themes. Northern Rock had three different lead supervisors in the two years before its failure and put insufficient resources to monitor a bank who business model (reliance on wholesale funding) was so clearly an outlier. In the US there were reports of widespread fraud in mortgage markets and evidence of heightened risk in banks through NINJA loans.

Did the market ‘miss’ the crisis? Not entirely. A number saw it coming-‘the Big Short!’-and market pricing suggested concerns. Returns on AAA rated CDOs were trading higher than AAA rated corporate bonds suggesting market risk skepticism while US and European regulators were still trusting the ratings on the securities. Equity markets were distinguishing between the ‘crisis’ banks that had to be bailed out or merged with others, compared with stronger banks, several years before the crisis (Haldane, 2011).

Bankers compensation and its impact on behaviour was certainly a factor in the crisis and probably a decisive factor in a few specific cases. Pay packages that favoured return, growth at all costs and did not adequately, if at all, weight risk, seem to have been pronounced in the crisis countries. In essence these were volume-based compensation models. There were instances of a bank generating assets that were said to contain ‘toxic waste’ and yet be on the buying side as well for these assets. Rating agencies adopted a similar model with pay based on the number of securities rated.

While bankers greed and incompetence undoubtedly played a part, hubris at the senior level was a significant issue, especially with regard to the catastrophic takeovers at this time.

Regulation is designed to protect us from ourselves. Ideal regulation should be based on simple rules that would actually be enforced allied to monitoring and accountability of regulators. However, “…the more complex the environment, the greater the perils of complex control.” Haldane and Madouros (2012). Regulation has had unintended consequences. It has increased market risk through its complexity and probably exacerbated the recession through its obsession with capital adequacy.

Since the 1980s the regulatory emphasis, nay obsession, has been on capital. The 1988 Capital Accord, or Basel I, adopted the approach of a minimum risk- weighted capital ratio, justified by the reasoning that banks differ in their degree of riskiness. Asset securitization took off in the 1990s, reflecting several factors, notably the differential risk weights in Basel 1-Government debt zero risk weight, Residential mortgages 50%, Mortgage backed securities 20% – and an increasingly quantitative approach to risk management aided by steep declines in the costs of computing and communicating. The result was that banks shed assets with higher risk weights to economize on their capital.

Basel 11, 2004 was based on three pillars: minimum capital requirements (focus), supervisory review and market discipline. It allowed banks to use their internal models to estimate their loss given a default; and allowed banks to go even further in using their own models to decide on their own risk weights. Most higher income and some middle-income countries were adopting Basel II in the 2004-2008 period.

Basel 111 2010/11 is an extension of the existing framework and introduces new capital and liquidity standards. The global capital framework and new capital buffers require financial institutions to hold more capital and higher quality of capital than under current Basel II rules. The new leverage ratio introduces a non risk-based measure to supplement the risk-based minimum capital requirements. The new liquidity ratios are designed to ensure that adequate funding is maintained in case there are other severe banking crises. I have doubts whether this will be effective in practice. The simple fact is that banks freeze and lending stops.

The general proposition though, is that higher capital ratios based on equity alone will insulate the economy from banking crises. Intuitively this must make sense. However, if the authorities demand higher capital/asset ratios then there are two options: raise more capital or shrink the balance sheet. If, as is obviously the case near impossible (or penal expensive) to raise bank equity in a crisis then lending has to be cut. The resulting collapse in money growth 2008/2009 is believed to have been a critical reason behind the Great Recession, at least until QE was adopted.

It was excessive debt of dubious quality that brought the house down. I have briefly outlined the many reasons for that outcome. An historical legacy of accumulated policy errors laid the foundations, benign neglect from the regulators and non implementation of existing controls and some breath-taking ‘banking’ contributed.

Perversely the authorities have treated the patient by encouraging the take up of more debt, now well in excess of 2007. We can see a history of unintended consequences and policy errors stretching back for decades and continued. We have also seen how individual decisions can frame the situation not purely from greed but from human vanity.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Trumponomics blog: April 2017

For those of you suffering from post Trump Election Stress Disorder a moment to look at economic policy according to Trump. It would not be unreasonable for you to believe that something new has been unveiled. The elements are certainly not but his cocktail of policies will either leave a huge hangover or a journey to economic nirvana. Before you lose any more nights sleep it is important to recognise that Congress may have different ideas.

Before I attempt to enlighten you on these policies it might be useful to see how the US economy is faring, which might have been coloured by Trump’s dismal description in his inauguration speech. Obama inherited quite a mess eight years ago. The US banking system was creaking, stock markets were falling, consumer confidence was at an historical low and house repossessions were at levels last seen in the 1929 Great Depression. Moreover, budget deficits were rising against falling tax revenues and foreign incursions. Today the picture is quite the reverse. The latest GDP figures show Q4 2016 growth at an annualised rate of 1.9%. The banks balance sheets have largely been repaired, credit is flowing-bond issuance in 2016 recorded an all time high of USD1.3trn, unemployment is at a 9 -year low of 4.7%, property prices are above prior cycle peaks, the budget deficit has reverted to a post 1980 mean and the Federal Reserve has started to raise (normalise) interest rates.

This does not sound too bad to me but is this goldilocks picture merely an illusion? In some respects, yes. Growth has only run at half that normally seen post recession (2016 GDP +1.6%) and for many even this has passed them by, which of course partly explains Trump’s election. If you have an equity portfolio life is good as QE, the most iniquitous policy ever constructed, bore its fruit. The notion of ‘trickle down’ economics is not much different in looking to the Lord of the Manor to share a bumper harvest with his tenants. US inequality-share of US income going to top 1%- according to World Top Incomes Database is at levels last seen in the 1920s.

So what has Trump up his sleeve or in his golf locker. He seems to have taken a bit from most economic camps. His end game is to deliver growth and jobs, particularly in areas blighted by ‘globalisation’. This will be through a combination of what some would view as Keynesian (deficit spending) and supply side (cutting regulations). The issue of globalisation will be dealt with by re writing trade agreements (an early exit from the Trans-Pacific Partnership TPP) or levelling the playing field (’symmetrical’ agreements), most notably with China. Commentators have seen this as anti trade or even the makings of a global trade war.

US trade deficits are not new. The US has run trade deficits since the late 1950s.It was the erosion of the US competitive position, most notably against Japan and Germany and an ill fated war in Vietnam which prompted the collapse of Bretton Woods in 1973 and ushered in a system of floating exchange rates. The basis of the US dollar reserve function (the currency most countries use to pay their debts) had been undermined but still retained the predominant medium for the settlement of international transactions.

Unlike Greece the US can’t run out of cash but large external deficits do pose risks because foreign investors might at some point refuse to finance these deficits on terms compatible with US prosperity. Any sudden stop in lending to the US would drive the dollar down, push inflation and interest rates up, and perhaps bring on a hard landing for the economy-and the world at large. It would be remarkable if China decided to shoot themselves in the foot by instigating such an event.

Trump’s answer to what he considers the US malaise (not altogether compatible with the data above) is to spend big on infrastructure ($1trn over 10-years!) and defence spending, which will be coupled with cuts in taxes. According to the Tax Policy Centre/US Budget Resolution estimates this would lead to a $7.2trn/$9trn rise in the Federal debt over ten years. Who is going to finance this debt and on what terms? Even after my recent blog caning economic forecasters I could not help myself and include the IMF view. Global growth 2017, 3.4% and 3.6%, 2018 in part driven by this US fiscal stimulus.

I have never been a strong believer in deficit spending as the road to any salvation. At best it is a stop gap, at worst part of a political survival kit. Prof Paul Krugman (Nobel prize winner and declared ‘liberal’) is an advocate of ‘depression economics’ where ‘virtue was vice’ and ‘prudence was folly’. So don’t try and balance the budget, keep on spending, after all money is cheap. We have heard that argument many times from the anti ‘austerity’ lobby in the UK when Chancellor Osborne’s plans were ridiculed. Much of course depends where your debt starting point is. What is baffling about this argument is that the financial crisis had its root in excessive leverage (debt) and, we can solve the problem with more debt. Jim has a drink problem so send him an extra case of scotch! Krugman could therefore be seen as a Trump supporter. But no, he now considers deficit spending is unnecessary as the US economy is approaching full employment. He is closing the bar. The argument runs ,more government borrowing competes with the private sector for available funds, drives up interest rates and ‘crowds out’ private investment. The issue with Trump is what form the deficit will take, lower taxes for wealthy (not a crowd pleaser or great boost to economy) or reduced corporate taxes and infra structure spending (favoured, but will the Congress go with it). The latter is only beneficial if it raises productivity-roads to nowhere add little.

To date the US and China have enjoyed a symbiotic relationship. China makes cheap goods, sells them to the US. China gets paid in dollars and then buys a piece of paper with US Treasury printed on the top earning some low rate of interest. Currently China has over $1trn of this ‘paper’. China is America’s third largest export market (after Canada and Mexico).

The thought that we are suddenly going to enter a period of protectionism is somewhat disingenuous. We are already in a protectionist world. The EU may laud itself on the internal market but it erects tariffs to the rest of the world. It protects its agriculture as a mother would protect her new born. The US is no better with numerous tariffs and restrictions on holdings of strategic industries. Tariffs are not the only means to protect, administrative and product specification can prove substantial obstacles. There is of course the exchange rate. The 21^st century is not that different to the 1930s when countries looked to devalue their currencies in order to gain competitive advantage.

As far as globalisation is concerned there is no point shutting the stable door when the horse has bolted. Some believe this process has stalled but others such as Prof Baldwin (Geneva Graduate Institute) believe the actual process has changed in the 21^st Century from trade led (movement of goods) to knowledge led (technology transfer combined with low cost labour). If you subscribe to this view tariffs will not succeed. The rust belt would be better served with regional policy, re-education. It also begs the question of how Apple and others will be dealt with, if at all. They produce their iPhone in China and then to add insult to injury and hoard their billions of profits offshore.

A major issue for President Trump going forward will be the exchange rate which he does not have much control over. The US Fed have started their tightening cycle (currently underpinning the dollar) while other major central banks still run an easy money bias. This may all about to change as inflation is on the turn in UK and Germany, which will lead to tighter monetary policies. Rising US debt may also start to erode recent gains.

Certainly the judgement on Trumpeconomics is how much protectionist policies (if indeed these do materialise) counter the impact of lower taxes/government spending on growth. The corporate sector may be energised by lower taxes and regulatory changes (and hoards of offshore held profits may be repatriated to boost the exchequer). Any thoughts of restoring the manufacturing base (currently 11.7% of GDP) are fanciful, as are the prospects of reversing globalisation, which the US multinationals have embraced. If reducing the trade deficit is a primary goal, then there is nothing in the policy mix to make a meaningful correction.

To quote Ed Murrow the distinguished American journalist ‘ Anyone who isn’t confused doesn’t really understand the situation’.

James Sharpe LSBU

Economics in Crisis

I spent decades in the ‘City’ trading and analysing markets. During this period, I made and relayed forecasts from all quarters. Over this period the cult of the City economist as guru/expert was born and flourished. This was also mirrored in the numbers of economists employed within Central Banks and institutions such as the IMF and OECD. There now was an army of ‘experts’ to pour over the most obscure data and for Central Banks to design and implement appropriate policy independently. This new freedom had much to do with the past where political interference in policy had seen lamentable results on both sides of the Atlantic. In the 1990s/2000s the US Federal Reserve under Greenspan was given reverential status and was able to dictate policy with little opposition.

Over this period there was also the rise of computational power which enlarged the scope for analysis, which fuelled a change in the nature of economics from a mainly narrative interpretation of the economic system to a mathematical one. It was believed that if we could model the economy we could make predictions, and with these in hand we could manage the economy more effectively. In essence it was a move to eradicate boom and bust or the business cycle as it used to be termed. To do this you required mathematical skills and so there was a drift from maths centric disciplines to economics where they were welcomed. What developed was a case of ‘physics envy’. Economics could be every bit as precise as physics if only we could the right equation! Political economy was dead. We have now got to the point where economic thinking is framed in mathematics and where only a coterie can enter the debate. It is akin to the Middle Ages where the monks controlled religious thinking and society through their exclusive use of Latin text. As recently as last week I learnt that two very capable past students of mine had to change from an economics MSc course because of its extreme mathematical content.

I have not yet used the word crisis. Well that is certainly the opinion of many and from no less than the Chief Economist and number cruncher at the Bank of England, Andy Haldane. The roots of this crisis have been gestating for some while and it it is not just because ‘scientists’ have hijacked the profession. This is certainly evident in papers I read where the process is regularly elevated above the substance. Economists are also reluctant to discard failure. They largely remain welded to Keynesian mantra and socialist principles. It is this ‘group think’ while not remarkable in a City context is extraordinary in an academic one.

While in the City I was regularly asked my opinion on what was going to happen. In other words, what are my my forecasts. The conversation usually started with the client saying ‘I know you don’t know what is going to happen but tell me what you think!’ After all I was an expert on foreign exchange! I have said many times (and in my book) you never trade off forecasts and forecasting is a humbling experience. There is though, (and always has been) an insatiable demand to know the future. The future, as far the forecasting community is concerned, is broadly the same. They cling to the consensus. No one wants to stand out alone as wrong. It is better for job protection that I am in the crowd. They also use similar models which don’t consistently work. Economic forecasters also tend to be divorced from the ‘market’ and do not usually have feeling on sentiment which is essential.

The perceived weakness in current modelling is that human beings are very difficult to predict and the economy changes so rapidly it is realistically impossible to incorporate. The principal characteristic of a market economy is incessant change: new goods, new technologies and new processes of distribution are constantly being introduced while existing ones disappear. Therefore, economic circumstances change continuously over time.

It is however behavioural issues which are currently drawing most of the attention and there is talk of further development of ‘Agency Based Models’ which take account of the observable environment but also the behaviour of other agents which interact with it. In this context a paper worth reading is ‘The Psychology of Prediction’ by Daniel Kahneman and Amos Tversky.

The long standing issues with the profession came to a head with the 2008 Financial Collapse and was followed by the Brexit debacle. The Queen referring to the financial crisis asked “how come nobody saw this coming?’, followed by a long silence. Haldane at least points out that economic models provided an exceptionally poor guide to the dynamics of either finance or the economy as the crisis unfolded.  Prof Robert Lucas (Nobel prize winner) seems in denial when he says ‘The simulations were not presented as assurances that no crisis would occur, but as a forecast of what could be expected to occur conditional on a crisis not occurring’. It sounds like gobbledygook to me.

The Brexit forecasts run closer to home and their impact continues to resonate socially and politically. I will present one example from H.M. Treasury who on 18^th April produced an “Analysis” of the consequences of Britain leaving the EU. It starts by saying it is presenting the ‘Key Facts’. Facts are normally associated with the past not the future. Even economic data cannot always be viewed as fact as key figures such as GDP and current account data are regularly revised. The Treasury/Office of Budget Responsibility struggle to correctly forecast its own budget twelve months hence. The same applies to the IMF, Bank of England etc. We recognise forecasting is a difficult task and it is not as though the staff are lightweights. They are some of the brightest on the planet. So if twelve months is tough how can we compute the economic outcome in five, ten or fifteen years time and yet the Treasury document states “the annual loss of GDP per household (as a consequence of leaving the EU)…. is £4,300 after fifteen years”. To compound this the document contains the additional claim that “A vote to leave would mean that Britain would be permanently poorer”. That may or may not turn out to be true, but there can be no scientific basis for such a statement whatsoever. Well there can be if you claim the analysis is solidly grounded in mathematical equations. The latter were even reproduced on BBC Television’s News at Ten. However, it is extremely unlikely that the underlying assumptions which underpin this statement will hold for such a long period of time. As Prof David Simpson put it ‘To express it in mathematical form is simply to transform it into nonsense on algebraic stilts’. Attempting to anticipate what will emerge over the next fifteen years is a triumph of hope over experience.

As I noted at the outset the rise of the economic expert and greater central bank independence was in part driven by previous political failures to manage the economy. We have now gone full circle and mainstream economics is the object of political derision. Public trust has been undermined and the independence of Central Banks is now being questioned. The risk now is that politicians will look to pursue there own economic agenda with relative impunity. Economists need to learn some humility and be more forthright on their limitations.

James Sharpe