The venue (the LSE) was certainly a highly pertinent place for the Queen to ask this question about macroeconomic forecasting, as, in the previous year (2007-8), the LSE had been the largest single institutional recipient of UK taxpayer finance for economic/econometric research funnelled via the Economic and Social Research Committee (ESRC: a quango, 100% taxpayer-financed). Moreover, it is now openly admitted by a leading (and Nobel Laureate) economist at the LSE, Professor Christopher Pissarides, that he and others at the LSE (as elsewhere) had failed to foresee the nature, timing and severity of the crunch.
However, such were the perturbations wrought in the Establishment ether by this Right Royal Question that the British Academy (technically/legally, a ‘charity’, concerned with the humanities and social sciences; in reality financed 90% by the UK taxpayer) felt it necessary to convene a meeting of the Great and the Good (in this instance, an admixture of eminent/orthodox macroeconomists and various mandarins) to consider a reply to the HM Question.
The subsequent 3-page missive (sent on 22/7/09 to HM) accepted that there had been a (very regrettable, but also very general) failure of macroeconomic forecasting in this particular instance, which had (they alleged) many causes; but was ‘principally’ due to ‘a failure of the collective imagination of many bright people’. If I interpret this (rather curious) phraseology correctly, the British Academy letter to HM is ascribing the failure of macroeconomic forecasting, in the matter of the crunch, to groupthink.
More recently, (Summer 2013 LSE Connect magazine) Professor Christopher Pissarides has, more candidly, admitted that: ‘mainstream macroeconomics, which played such a role in defeating inflation and (we thought) in large fluctuations in economic activity, has come under criticism, and rightly so. To put it bluntly, we did not know what hit us [in 2007-9]’.
However, the general ( and repeated) failure of macroeconomic forecasting to predict the future is actually nothing new at all; and is not a matter confined to the last bust (of 2007-9). Just under a decade ago, Paul Ormerod – himself a former (and leading) macroeconomic forecaster at the NIESR and other bodies – (accurately) described the track record of macro-forecasting as ‘appalling’ (nothing has changed since then). Moreover, the tendency towards groupthink is a well-known dimension not only of ‘policy-making’, but also amongst the band of (supposedly competitive?) macroeconomic forecasters.
A considered, logical (dare I say ‘rational’?) response to these (very longstanding) realities might be:
(a) To accept that there are profound, and quite fundamental, constraints upon our ‘ability’ to make accurate macroeconomic forecasts;
(b) To curtail/reduce/eliminate taxpayer subsidy of this macro-quackery;
(c) To encourage (without taxpayer subsidy) more substantive economic analysis, as an alternative to the appalling stodge of current ‘mainstream, macroeconomic, orthodox’ blarney.
But what has the ESRC actually done? …quite the opposite of the above rational suggestions: at an (announced) cost to taxpayers of £5m, it has set up a new Centre for Macroeconomics, based at LSE and chaired by Christopher Pissarides, but also encompassing (we are told) ‘University College London, Cambridge University, the Bank of England, the NIESR; and “other leading global institutions” ‘ [read: a charmed circle of selected insiders?].
Also (ominously) another aim of this seriously dubious venture is to ‘give policy-makers access to cutting edge (macro) research, and [to] provide academics with stimulus from policy circles’ [read: a classic recipe for both the groupthink and the revolving doors problems].
I should perhaps note, at this point, that I hold both Professor Pissarides, and the LSE more generally, in the highest regard (in fact, I am an alumnus of that august institution). Unfortunately, however, I am also able to predict, with 100% certainty, that the new Centre for Macroeconomics will not be able to improve our capacity for macroeconomic forecasting.
The reason for this was (partially) explained by another Nobel-Laureate economist (and sometime LSE Professor), Friedrich Hayek, back in 1974. Economics concerns what he labelled as ‘structures of essential complexity’, which we do not have the capability to precisely forecast (apart, perhaps, some rather general predictions as regards possible ‘pattern’ outcomes).
Indeed, I must submit the problems underlying macroeconomic forecasting are even more severe than those which Hayek described over 30 years ago. Econometric analysis assumes (for the purposes of estimation) that the underlying economic structure is: (1) known in (equational) outline (subject to stochastic variances, conforming to a Gaussian distribution); and (2) is stable/unchanging. These basic assumptions are clearly breached in reality: we do not have the certain knowledge presupposed by item (1), for example, what is the size of the shadow economy in the UK; what is the size of the gangster economy in Russia, and how does it operate? Secondly, far from being stable and unchanging, the global economic system is rapidly mutating and evolving (a matter reinforced by unpredictable changes in politics, and regimes, across the world). Until the econometrics profession can tell us how these quite fundamental considerations can be overcome, all talk of better macroeconomic forecasting must be treated with reserve; why expensive intellectual follies should be subsidised by taxpayers should also be a matter of concern.