By Samuel Brittan
Published: May 14 2009 22:13 | Last updated: May 14 2009 22:13
We have been told by that usual bringer of bad tidings, George Soros, that the "economic freefall" has stopped. The normally cautious president of the European Central Bank, Jean-Claude Trichet, has identified a slowing down of the rate of decrease in gross domestic product and, in some cases, "already a picking up". The Organisation for Economic Co-operation and Development composite leading indicator shows at least a slight uptick. The admittedly highly erratic Easter UK retail sales figures show an actual increase and surveyors report more property inquiries. Financial commentators talk of "green shoots" and one of them has even suggested that the recession came to an end in April. So – Bank of England dissenting – everything is all right and we can get back to normal life.
Except that it isn't. It is perhaps unfair to cite the continuing horrifying rise in unemployment in so many countries. For that is admittedly a lagging indicator. A better reason for being suspicious is that so much of the new optimism is associated with a very recent recovery in equities. These lost up to half their value in the key US and UK markets, but have come less than a third of the way back since early March. Paul Samuelson once said that the stock market had predicted eight of the last five recessions. The same might be said of recoveries.
There is also a little matter of arithmetic. UK GDP is estimated to have fallen at an annualised rate of 7.4 per cent in the first quarter of 2009. So it is as well that the rate of decline is itself declining. A more specific factor is that a drop in stocks much amplifies any recession. As the Bank of England inflation bulletin explains: "De-stocking only reduces GDP growth if the fall in stock levels is larger than the fall in the previous period." When this no longer happens the recession looks less draconian; but it does not mean that it is over.
In fact, I have never shared the gloom-and-doom, end-of-capitalism attitude to the credit crunch. Injecting public funds into failing banks was not the best way to bolster demand and credit, especially as governments have relied upon these very same bankers to advise them. Critics on the left and right agree on this matter and are largely right. Nevertheless, governments and central banks have probably injected enough cash into the world economy to prevent the worst from occurring. Sound money commentators fret about the difficulties of withdrawing the stimuli in time. They should equally worry about the danger of withdrawing them too soon. One reason why US unemployment remained so high in the New Deal period is that a premature monetary tightening and attempt to balance the budget aggravated a new recession in 1937.
There has been much discussion about whether the present recession will be V-shaped, which is what national authorities would like; W-shaped, in which a modest recovery would be followed by a further downturn; or L-shaped, in which output stops falling but we crawl along at the bottom without getting back to normal trend growth. Having exhausted suitable letters of the alphabet, commentators talk of bath-shaped and hook-shaped recessions as well.
The truth is that we do not know. To me the most dispiriting aspect of current discussion is the way in which both governments and their critics still cling to national income forecasts, known in the trade as "NIF". The value of such forecasts is not to be judged by their average record over several years, but by whether they signal problems and opportunities in advance of turning points. Here their record is abysmal. At the beginning of 2007 both national and international mainstream forecasters looked ahead to a golden period of good growth with low inflation, oblivious to the credit crunch that was to hit us later the same year. This should have been the coup de grâce, but it was not. There is no solution in putting wide ranges of error on the predictions – what one economist called "giving them wings". New Bank of England charts show a range of between minus 2 per cent and plus 6 per cent for output growth in 2011 and 2012, which is honest but useless.
I recently heard a well-known forecaster say that the only valid question is which forecasters to go by and what methods they should use. Not so. New mathematical theories of chaos and complexity provide insights into why forecasting is so problematic but do not provide alternatives. We just have to accept that the future cannot be foreseen in the way many governments and businessmen would like.
Let me end with a simple illustration. The weather in summer in north-west Europe is known to be highly variable. Somebody going away for a fortnight in that part of the world would find it helpful to have a day-by-day prognosis of temperature, rainfall, sunshine, wind conditions and so on. But apart from the first day or two it cannot really be done. Rather then rely on long-term weather bureau predictions, it is safer to take an umbrella or raincoat and a warm pullover as well as sunglasses and a sunshade, even at the cost of slightly heavier luggage. Now apply this homely little story to economic policy.
Except that it isn't. It is perhaps unfair to cite the continuing horrifying rise in unemployment in so many countries. For that is admittedly a lagging indicator. A better reason for being suspicious is that so much of the new optimism is associated with a very recent recovery in equities. These lost up to half their value in the key US and UK markets, but have come less than a third of the way back since early March. Paul Samuelson once said that the stock market had predicted eight of the last five recessions. The same might be said of recoveries.
There is also a little matter of arithmetic. UK GDP is estimated to have fallen at an annualised rate of 7.4 per cent in the first quarter of 2009. So it is as well that the rate of decline is itself declining. A more specific factor is that a drop in stocks much amplifies any recession. As the Bank of England inflation bulletin explains: "De-stocking only reduces GDP growth if the fall in stock levels is larger than the fall in the previous period." When this no longer happens the recession looks less draconian; but it does not mean that it is over.
In fact, I have never shared the gloom-and-doom, end-of-capitalism attitude to the credit crunch. Injecting public funds into failing banks was not the best way to bolster demand and credit, especially as governments have relied upon these very same bankers to advise them. Critics on the left and right agree on this matter and are largely right. Nevertheless, governments and central banks have probably injected enough cash into the world economy to prevent the worst from occurring. Sound money commentators fret about the difficulties of withdrawing the stimuli in time. They should equally worry about the danger of withdrawing them too soon. One reason why US unemployment remained so high in the New Deal period is that a premature monetary tightening and attempt to balance the budget aggravated a new recession in 1937.
There has been much discussion about whether the present recession will be V-shaped, which is what national authorities would like; W-shaped, in which a modest recovery would be followed by a further downturn; or L-shaped, in which output stops falling but we crawl along at the bottom without getting back to normal trend growth. Having exhausted suitable letters of the alphabet, commentators talk of bath-shaped and hook-shaped recessions as well.
The truth is that we do not know. To me the most dispiriting aspect of current discussion is the way in which both governments and their critics still cling to national income forecasts, known in the trade as "NIF". The value of such forecasts is not to be judged by their average record over several years, but by whether they signal problems and opportunities in advance of turning points. Here their record is abysmal. At the beginning of 2007 both national and international mainstream forecasters looked ahead to a golden period of good growth with low inflation, oblivious to the credit crunch that was to hit us later the same year. This should have been the coup de grâce, but it was not. There is no solution in putting wide ranges of error on the predictions – what one economist called "giving them wings". New Bank of England charts show a range of between minus 2 per cent and plus 6 per cent for output growth in 2011 and 2012, which is honest but useless.
I recently heard a well-known forecaster say that the only valid question is which forecasters to go by and what methods they should use. Not so. New mathematical theories of chaos and complexity provide insights into why forecasting is so problematic but do not provide alternatives. We just have to accept that the future cannot be foreseen in the way many governments and businessmen would like.
Let me end with a simple illustration. The weather in summer in north-west Europe is known to be highly variable. Somebody going away for a fortnight in that part of the world would find it helpful to have a day-by-day prognosis of temperature, rainfall, sunshine, wind conditions and so on. But apart from the first day or two it cannot really be done. Rather then rely on long-term weather bureau predictions, it is safer to take an umbrella or raincoat and a warm pullover as well as sunglasses and a sunshade, even at the cost of slightly heavier luggage. Now apply this homely little story to economic policy.
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