Archive for July 31st, 2008

A proposal to limit flipping behavior of experts

July 31, 2008

There is nothing more annoying than to see the ongoing flipping behavior of experts giving their outlook on Indian economy/financial markets. I have been noting it for a while now. I wrote a longish article to explain the flipping and some measures to minimise it.

The Business media has grown substantially in India in recent years with new launches both in television and in print. With it has grown substantial commentary and analysis by experts on various economic and financial markets events. It provided benefits as people got diverse views, financial education etc but recently it has become confusing. The confusion mainly stems from the continuous flipping of views by various experts.


Prior to RBI Monetary Policy in April 2008, the view was inflation is benign and large market participants were instead concerned with growth. So, on both counts there was an emerging consensus that RBI should lower the interest rates. Some even mentioned India is facing stagflation – a situation of rising inflation and declining growth. However, both views were doubtful. 


Inflation was expected to move higher because of rising commodities and oil prices. The pass-thorough of prices was not taking place and it was a matter of time for oil prices to be revised upwards. Hopefully, the experts know it well that inflation expectations are as critical as actual inflation. And this was not just relevant to India but other regions as well with most Central Banks being concerned (why they didn’t act is a matter of separate discussion). In growth, the main concern was decline in Index of Industrial Production (IIP). Again, there was a problem as IIP was prepared in 1993-94 and does not include many items that are in high demand today (DVD players, LCD players etc). This has been raised in many forums by the respective industry associations. Then, the other indicators like growth in Credit, Money Supply etc have been higher than RBI’s preferred targets for a while. The housing prices also continued to move up. So, clearly the so-called slowdown and benign inflation was not really correct. It was rather a case of buoyant growth and inflation waiting to show in numbers.


Now when the inflation is nearing all time highs and recent GDP numbers indicated another year of 9%, most have done a flip on their views.  They have even flipped from the equity market outlook from extreme optimism to extreme pessimism. Some who advocated rate cuts then even say RBI should have increased rates earlier! Moreover, the analysis has gone berserk with experts saying inflation has moderated (cooled down) when it was noted at 11.89% compared to previous week’s 11.91%! This is confusing as, in both economic and financial market outlook, the risks have been seen for a long time and pointed by the same analysts. So, this was all but waiting to happen. What you see is the same experts now talking just the opposite. It is a problem as people follow the advice of the experts to form their own expectations, which is also the main purpose of these various media channels.


However, experts might object and say that economic and financial Markets outlook has changed suddenly and so have their views. And then this forecasting business is complex with best in the business failing miserably. Still experts have to forecast as it leads to formation of expectations. The dilemma is best summarized by Bernanke in his speech (November 14, 2007):


The only economic forecast in which I have complete confidence is that the economy will not evolve along the precise path implied by our projections.  Nevertheless, as I have already noted, because policy affects spending and inflation with a lag, Committee members have no choice other than to make medium-term forecasts–provisional and subject to uncertainty though they may be.


Fed Economists David Reifschneider and Peter Tulip evaluated FOMC forecasts in a paper and said “if past performance is a reasonable guide to the accuracy of future forecasts, considerable uncertainty surrounds all macroeconomic projections, including those of FOMC participants.” In 1997 when Bank of England was given an inflation targeting framework, Charlie Bean had projected that BoE was likely to deviate from the inflation target by more than 1% in nearly five months every year. BoE missed the target only twice, once in April 2007 and now in June – 2008.  In another speech, Riksbank Governor evaluated its forecasting performance and said the forecasts are better towards the short-term and only for some variables (inflation and unemployment). Hiroko Oura compiled all the empirical papers forecasting Indian growth and range was 7.4% to 8.1% in 2006-07 and the actual was 9.6%! RBI publishes forecasts of various agencies in its quarterly Macroeconomic and Monetary Development report and it also conveys the same- most underestimate the growth potential. So, with so much uncertainty what are the solutions?


In a fantastic paper, (Economists as Experts: Overconfidence in Theory and Practice), Erik Angner shows how overconfidence amongst economists leads to worse policies. The learnings of the paper can be applied to the above problems as well. Mostly economists convey their outlook with a lot of overconfidence, as then only they will look credible. And as there is no penalty for flipping and public memory is short and no one remembers what was said earlier, they can change their views conveniently next time. In Angner’s words “If you are a baseball player, you have to live with your batting average until the day that you die. If you are an economist, you can advice the government of Russia for years without being forced to critically examine your hit rate.”


There are a few suggestions to check this behavior. First, economists/analysts need to also project how likely is it that this forecast doesn’t happen. This will also help people make their own estimates and not rely blindly on the experts. Second, we need to show the earlier projections of the same economist/analyst with the current forecast and in case of a flip ask for the possible reasons. This will provide more clarity to the viewers/readers and also keep an auto-check on the analyst who cannot flip for the sake of it. Though, this might take more newspaper space/ channel-time but it is surely worth it. It is complex to forecast but it has to be seperated from mere crystal gazing.


Assorted Links

July 31, 2008

1. WSJ Blog reflects on the new liquidity measures taken by Fed. It also points this might indicate Fed may not increase rates anytime soon.

2. WSJ Blog points to a study analysing the impact of fiscal stimulus

3. Krugman not surprised by Doha failure. Rodrik says no need to panic as there were hardly any gains for poor countries

4. PSD Blog points to a new paper from Thorsten Beck which says:

We find that it is bank lending to enterprises, not to households, that drives the positive impact of financial development on economic growth.

5. Ajay Shah responds to the monetary policy announcements ( he calls it credit policy as he believes we don’t have a monetary policy in India) . He says – “we need to see that this kind of shock therapy is not what a mature market economy does”. He calls India a mature market economy!!

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