News Brendan Keenan

Friday 28 October 2016

Don't predict recession - just be prepared for one

Published 28/01/2016 | 02:30

THERE was a bit of fuss the other day over claims that the IMF (International Monetary Fund) failed to predict a single one of the recessions around the world since 1999. But actually, it doesn't say on the tin that it will.

  • Go To

That is kind of convenient, since the Fund's member governments would not care to be told that their economy was due to start contracting in, say, 18 months' time. Not unless it was a certainty. Which of course it isn't.

A better reason for this lack of dire predictions is that recessions cannot be forecast. Nor indeed can recoveries.

Our recent experiences should make us well aware of this. Mathematically, the Irish growth rates of the early 2000s could not go on for ever. But when would they stall - and how? Hard landing or soft landing?

The occasional politician and property developer could be found to say there would be no landing at all. That could be dismissed although, as any nervous flyer can testify, no landing ever feels soft. But one could apply only probabilities as to whether what was coming would be a crash, a recession or merely a downturn. As for when - forget it.

It has been the same at the other end. There were people who said there would be no recovery at all, and hardly any who forecast it would be early and vigorous, in the way it turned out to be. Behavioural economics says we are more prone to pessimism than optimism.

It's all about behaviour. Perhaps one day, those behavioural economists will be able to predict when people will take fright, or decide they have run out of money, or conclude that the sun is shining again. But I doubt it.

The problem is simple enough. What is known as forecasting is actually an, admittedly sophisticated, extrapolation of past trends and current conditions into the future. In in a recent edition, 'The Economist' newspaper outlined the sophistication, but also did some measures of forecasting accuracy with, naturally, the IMF as guinea pig.

The conclusion would seem to be that medium term forecasting - never mind long-term - is pretty useless. ('The Economist' could not resist quoting JK Galbraith, "The only function of economic forecasting is to make astrology look respectable.")

Even nine months into a year, the forecasts for growth that year - which might be considered more of an estimate - were typically wrong by 1.5 percentage points.

Not per cent, percentage points; so growth might turn out to have been 1.5pc rather than the predicted 3pc.

Forecasts of more than 18 months had a mean error of 2.5 percentage points. In terms of economic growth, that is the difference between chalk and cheese. And, as mentioned, there were no predictions at all of a recession in the following year. On the other hand, simpler methods tried by the newspaper fared even worse.

Talk of recession is again in the air. At times like this, it is important to realise that no official body - and no government - is going to say that one is coming and no unofficial forecaster, however pessimistic, is able to say with any certainty when it is coming, or how bad it will be.

Faced with such uncertainty, all kinds of other oracles have been sought. There is a particular fondness for abstruse measures of financial market behaviour.

One of the better results appear to come from counting how often the 'R' word appears in US newspapers. Both deal in human behaviour, so maybe there is something in them.

We are in one of those periods when the official pronouncements have to be treated with particular care. The figures in this month's IMF World Economic Update see the next two years as almost untroubled. The West and Japan will trundle along, Chinese growth will decline by three-quarters of a percentage point (although when you're growing at 7pc, that's a lot of renminbi). The severe Brazilian recession already under way will end in 2017).

The IMF's language, though, is less sanguine. With the Fund, it may be better to read between the lines of what it says rather than looking at the numbers it produces, impressive though they look on screen.

On that basis, there is a good deal of trouble around.

There are important risks to the outlook, the Update says, including a sharper-than-expected slowdown in China, a further appreciation of the dollar, tighter global financing conditions and a sudden bout of global risk aversion. And, of course, the danger of an escalation of geopolitical tensions.

If forecasting is no more than assigning probabilities, it goes without saying that all of the above are distinct possibilities. If all were to happen together, the odds of another global recession would be very high. The fact that ECB president Mario Draghi chose to polish his rate-cutting sabre last week can be seen as a worrying sign.

Such uncertainties make politicians' lives very difficult. There are no votes in preparing the ground for a recession which does not arrive. The economic cycle tends to be longer than electoral one and no government wants to hand over unused resources to its successor. Even if recession hits, there may be precious few votes in arguing that the inevitable hardships would have been worse if the government had not prudently squirrelled something away.

One can see why prudence is so difficult to embrace. Nevertheless, we ought to do something to change Ireland's rating as one of the least prudent countries, based on its historical tendency to inflate booms and reinforce recessions to a greater degree than most.

The new European rules are meant to force prudence on governments but we shall have to wait to see if any such regime can work in practice. If things go as well as Irish government predictions say, there will be a new kind of tension between government wanting to spend money that is readily available, and the Brussels regime which says such spending is not permitted.

Paradoxically, there may be less such tensions if a recession comes. The one area where Irish governments have a reputation for prudence (or is it parsimony?) is in reducing deficits.

Whatever its makeup, one expects the next government will behave the same way if an economic slowdown requires it. The tensions will be domestic, and the could be fierce.

Amid the snows of Davos, the Taoiseach cheerily dismissed the idea that anything could go wrong. One can hardly blame him either for not wanting to upset people within weeks of an election but the one certainty is that he cannot possibly know. Given the probability that he will be the next Taoiseach, let's hope he knows that too.

Indo Business

Read More