Forecasting the Great Recession: listen to the mavericks!

Did anyone forecast the Great Recession that has created so much suffering across the world for close to a decade? The answer is yes, but they tended to be from outside positions of power and either kept quiet or were ignored.

The Bank of England’s Chief Economist, Andy Haldane, recently claimed that ‘big improvements’ have been made in its ability to forecast the British economy. If this is true, it is undoubtedly welcome.

Haldane highlights the failure to take account of high and rising borrowing levels, but still admits that the Bank is ‘not going to forecast the next recession’, since their ‘models are just not that good’.

Greater forecasting success fell to more heterodox economists, those from outside the mainstream, whose work was more prescient. Post-Keynesians such as Wynne Godley and Steve Keen, classical or Marxist economists like Anwar Shaikh and Michael Roberts, as well as some from the Austrian school, are prominent examples.

I am not so familiar with the work of modern Austrian school economists, but the work of the others mentioned above incorporated economic variables typically ignored by the mainstream, such as the role of private debt and cycles in economy-wide profitability and prices.

Of course, none of these thinkers got it all right, but their relative success makes their work worth following when looking ahead and trying to make sense of the evolution of the economy.

Here are some quotes which illustrate the thinking of Godley, Keen, Shaikh and Roberts:

“The late Cambridge (UK) economist Wynne Godley and a team at the Levy Economics Institute built a series of strategic analyses of the US economy on this insight, warning repeatedly of unsustainable trends in the current account and (most of all) in the deterioration of the private financial balance. They showed that the budget surpluses of the late 1990s (and relatively small deficits in the late 2000s) corresponded to debt accumulation (investment > savings) in the private sector. They argued that the eventual costs of servicing those liabilities would force private households into financial retrenchment, which would in turn drive down activity, collapse the corresponding asset prices, and cut tax revenues. The result would drive the public budget deficits through the roof. And thus – so far as the economics are concerned – more or less precisely events came to pass.”

James K. Galbraith (2012), Who are these Economists anyway? in Contributions to Stock-Flow Modeling

With a similar focus on private debt accumulation and what would happen when its unsustainable nature tipped it into reverse, Keen writes:

“The post-Keynesian and Austrian schools of thought explicitly consider credit and money in their models of the economy, and many economists in these schools expected a crisis – the former group because of their familiarity with Hyman Minsky’s Financial Instability Hypothesis, and the latter because of their familiarity with Hayek’s argument about the impact of interest rates being held too low by government policy. However, the vast majority of these did not go public with their warnings…

What distinguished me (and the late Wynne Godley) from the rest of these prescient and voluble few is that I had developed a mathematical model of how this crisis might come about. That model put into dynamic, disequilibrium form the economic vision of the late Hyman Minsky, which was in turn built on the insights of the great non-neoclassical thinkers Marx, Schumpeter, Fisher and Keynes. Minsky’s strength was to weave these individually powerful and cohesive but incomplete analyses into one coherent tapestry that explained capitalism’s greatest weakness: its proclivity to experience not merely economic cycles, but also occasional depressions that challenged the viability of capitalism itself.”

Steve Keen (2011), Debunking Economics, Ch.13, p.326

Anwar Shaikh, who works in the classical tradition of Smith, Ricardo and Marx, but also draws on Keynes and his followers, made a prediction in 2003 for a severe recession based on the theory of long waves in prices and profitability:

“The reader will note that the Great Depression of 2007 arrived quite on schedule…

…data from 1897 shows two clear long waves: 1897-1939 (forty-two years) and 1939-1983 (forty-four years), trough-to-trough. General crises break out eight to nine years after each peak and last to roughly eighteen years past it. In classroom and public lectures beginning in 2003, I used the average wave in conjunction with the peak in 2000 visible by then to project the next crisis as beginning in 2008-2009 and lasting until 2018.”

Anwar Shaikh (2016), Capitalism, Ch.16, p.727

Michael Roberts, a Marxist economist, also draws on theories of long waves and profit cycles and wrote in March 2006:

“Our graphic shows that capitalism (at least the G7 economies) is now heading for a combination of troughs in all its economic cycles (the motion of capitalism) that will coincide about 2010. The profits cycle is in a downwave alongside the Kondratiev cycle. Capitalism is in its ‘winter’ period – making it vulnerable to crisis.”

Michael Roberts (2009), The Great Recession, p.74

You may not want to replace capitalism with centrally planned socialism as Roberts does, but for me these kinds of forecasts should be listened to. Robert’s blog address is titled ‘the next recession’; he is clearly focused on the flaws of capitalism rather than its positive achievements. But as with Godley, Keen and Shaikh, he has a theory which can be used to understand the present as well as the future trends of capitalism.

The Bank of England could do with learning from these non-mainstream economists, if it has not done so already.

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2 thoughts on “Forecasting the Great Recession: listen to the mavericks!

  1. Thanks for this excellent synopsis. It’s been a long time since I was conversant with libertarian/Austrian explanations of the GFR. I seem to remember them being strong on state-critical aspects; it’s not just a lack of regulation (as the left insists) that contributed to the crisis, but regulation, as the Austrians stress, that created the wrong incentives mattered significantly as well (for instance government policies softening up credit policies by threatening banks with charges of racism, government policies driven by affordable housing ideology (Thomas Sowell has interesting stuff on this), or dubious capital weights prescribed in the Basle regulations for banks etc.)

    Authors on the left, like the ones mentioned in your post (but also Mitchell or Palley), however, seem to have better explanations of the prehistory and actual mechanics of the crisis than do Austrians, who tend to cling to von Mises theory of crisis, which I have never considered to be compelling at all. Austrians predict the next crisis all the time with great urgency, so when a crisis happens they get it right—in the broadest sense. The better authors on the left are good at analysing flaws in capitalism (whose incidence the Austrians ignore in principle), the classical-liberal/libertarian wing tends to be good at ferreting out government failure (but overdo it by turning government-critical vigilance into an across-the-board anti-government dogma).

    • Thanks for this reply and apologies for taking so long to address it. I’m not so up to speed on Austrian school, but I get the impression that their theory of cries is always about government failure, as you suggest. The state and the national/international market go together, and one cannot exist without the other in my view, so the state and market inevitably interact as economic development proceeds (or not).

      The state or the market cannot be wholly blamed for the recent crisis, or any other, but the relationship between them, and their relationship to entrepreneurs and businessmen, as well as ordinary workers is perhaps key. Like you I have found leftist writers to offer richer explanations and understandings of these sorts of events.

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