The reliability of economic forecasts has been questioned again
Every economic crisis tends to also become a crisis in economics—as events throw an unsparing light on the gaps in our knowledge of how an economy works. It is not different this time round either. Christine Lagarde, a former managing director of the International Monetary Fund who is now president of the European Central Bank, did not pull any punches in a speech she delivered at the annual World Economic Forum jamboree at Davos this month.
She attacked economists as a tribal clique that does not reach out to experts outside their narrow world. She then said that part of this certitude may have to do with the models that economists depend on to make sense of the world. Earlier, in August 2023, Lagarde, a lawyer by training, spoke on how policymakers need to negotiate what she described as an age of shifts and breaks.
“We rely on past regularities to understand the distribution of shocks we face, how they will transmit through the economy, and how policies can best respond to them. But if we are in a new age, past regularities may no longer be a good guide for how the economy works." She called for clarity, flexibility and humility. Two alternatives are worth considering—as complements to rather than replacements for the existing statistical models that economists use.
The first is building alternative scenarios, or a set of possibilities that tell us what may happen in the future, rather than certainty about what will happen. The Anglo-Dutch energy giant Shell had pioneered this approach in the 1970s, another decade of dramatic shifts in the global economy as well as geopolitics. To be fair, standard economic forecasts do offer probabilistic outlooks at various confidence levels.
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