Forecasting Crashes and Recessions
What Macroeconomists Don't Know
by Hernán Cortés Douglas
History does not repeat itself...but it rhymes —Mark Twain
"This expansion will run forever." Not two years, or three, or ten. Forever. That was how an MIT Professor of Economics summarized his vision of the U.S. economic expansion in the July 30th, 1998 issue of the Wall Street Journal.
Nowadays his assertion appears extreme. It did not then. This exuberance was rationalized by the obvious fact this was a New Economy with no room for recessions. Dornbusch himself said the American economy would "not see a recession for years to come"? Mmmm, why? Because, Dornbusch again, "We don't want one, we don't need one, and, as we have the tools to keep the current expansion going, we won't have one." "We", apparently, are the macroeconomists.
More Dornbusch: "Only natural causes, and not the Fed, can bring the economy to a standstill. Fortunately, we have the monetary and fiscal resources to keep that from happening, as well as a policy team that won't hesitate to use them for continued expansion."
In the latter part of the 1990s, euphoria was rampant and not only in the States. "It is hard to imagine any article with worse timing than, say, 'Asia's Bright Future,' by Harvard Professors Steven Radelet & Jeffrey Sachs, writing in the November/December 1997 issue of Foreign Affairs". So J. Orlin Grabbe told us. Their article was published at the precise moment East Asian financial markets and economies were deepening their collapses. As Grabbe put it: "Of course Asia probably does have a bright future, much as Europe could have been said to have had a bright future during the Black Death years of the 14th Century."[1]
It is one thing to say crises are undesirable, but another to say macroeconomists are, firstly, so skilled at forecasting they can predict trend breaks to the downside; and secondly, they have the tools and the policy teams to avoid economic and financial crises. If this were so, why do they utterly fail over and over again at forecasting economic downturns? Why do they have to adjust their projections over and over in times of trend change? Why has Japan stagnated for 11 years and had three recessions during that time?
The dismal record of forecasting crashes and recessions we economists have is not new. The crash of 1929 and the Great Depression came as an unexpected avalanche to economists, particularly those in the hall of fame..........
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