You can't predict the future so stop trying to
Over the summer, I wrote about the economy and where it might be going. The short answer was that I had no idea. That has not changed. The problem of trying to predict where things may be going is a problem not unique to economics, but common in many other areas. We really cannot predict the future.
This article discusses the drama that has been going on in the UK since now former prime minister Liz Truss announced her fiscal plan. The announcement of it was so negatively received and the market reaction so furious that she was forced to pare back her plan and then resigned as prime minister after just 44 days in office.
That whole episode was a good demonstration of how even the most sophisticated players have such a limited ability to predict things that are outside of lived experience. In 2018, the Bank of England (BOE), the UK’s version of the Fed, mapped out a scenario where interest rates on British bonds, known as gilts, surged. It asked whether such a surge in interest rates would cause a panic resulting in a mass selloff of bonds that would require the BOE to intervene.
The BOE concluded that even if gilts increased by 1 percentage point, which had never happened before, there would be no problem. Soon after Liz Truss’ fiscal plan was announced, gilts increased by 1.27 percentage points and there was a large selloff of bonds. The BOE was forced to intervene and buy bonds to stop it.
I do not mean any of this as a knock on the BOE. Everyone there knows galaxies more about economics than I ever will and I have no doubt they did the best they could. What should they have done differently when making their prediction in 2018? I have absolutely no idea. That is lightyears beyond my expertise. Nobody has ever accused central bankers of having an easy job. In the economy of today, their job is not only extremely difficult, but usually thankless, too.
I do not envy anyone in any position of power having to deal with the economy right now. As the article notes, the last three decades have had events happen that were on nobody’s radar. Often times, those events were thought to be impossible by almost everyone. It just goes to show the limits of our foresight and imagination. That is the world we live in for good or ill.
The premise of the article though is about the future. It is arguing that we may be in for an era of higher interest rates and higher inflation. It could be that the era of low interest rates and low inflation that we have experienced for the better part of 30 years is over. Certainly, you can find plenty of evidence suggesting that.
There is a case to be made that the low inflation we have seen since the 1990s was a product of some one-time events that are over and will not repeat. For example, we saw a huge influx of workers into the global labor force from China beginning in the 1970s. That almost certainly had the effect of lowering inflation by providing a big source of labor, reducing its cost and reducing the cost of goods and maybe services, too. That huge entry though has probably run its course. The effects of it may be coming to an end and there is no large new source of labor waiting to enter the global workforce.
Still, we really have no idea how that will pan out. We are in uncharted waters. It is tempting to compare today to past times. That is understandable because we want to have a reference point. We want to have guidance so we can know what to do and what not to do. It is very unsatisfactory to be told that we are in a world none of us have ever been in and what has happened before only has, at most, a limited amount of relevance now.
To be clear, I am not writing this out of hopelessness or despair. We could wind up somewhere bad, but things could go well, too. Many economists seem to think we are headed for a recession because of efforts by the Fed to fight high inflation. That is entirely possible, but we really do not know. As I mentioned in the piece I wrote over the summer, economists are notoriously bad at predicting recessions. When you stop to think about it, it makes sense. If they were actually good at predicting recessions, they would be billionaires many times over and not teaching at a university or working at a think tank.
On the subject of whether we will have a recession, it is often pointed out that, historically, bringing down inflation necessitated a recession. That was true in bringing down inflation during the 1980s. I am not very familiar with the history of central banks dealing with inflation other than that one time, but there may have been other such episodes. The problem I have with pointing to past episodes is twofold. One is that none of those situations dealt with a pandemic and probably not with messed up supply chains either. The other is that the sample size is extremely small.
To give an example of why pointing to past episodes is problematic, this article mentions the history of the Fed consistently underestimating by 1 or more percentage points how high unemployment would go during recessions for the last 50 years. That sounds scary, right? But when you look at the number of times the Fed was wrong about unemployment, the sample size is just 3. There were 3 times when the Fed underestimated how high unemployment would go by more than 1 percentage point, which was during the downturns in 1975, 1982 and 2009. None of those situations involved a pandemic nor did they involve supply chain issues, both of which we are dealing with today.
In any event, 3 is not 0, but it is a long way from 300 or 3000. I am not saying the Fed’s current unemployment forecast will be right. I have no idea although I certainly hope it is right given that it is very low. My point is that we have so little actual experience that drawing sweeping conclusions about the future from it is a fool’s errand.
While I certainly would not recommend taking this approach categorically, there is a part of me that thinks that whatever the conventional wisdom on the economy is will be wrong and that you should believe the opposite. That may be some of the best evidence that a recession does not happen. Most observers last year seemed to think that inflation would be quick and no big deal. Now it seems the widely held conventional wisdom is that we are doomed.
I am not predicting this happens, but my gut instinct is that if everyone thinks a recession will happen and acts accordingly, it may just have the effect of stopping one from happening in the first place. That certainly is what the Fed would want to have happen. As the article I first linked to notes, beliefs that events are impossible, such as a nationwide housing bubble, can make them inevitable. Maybe the reverse can be true.
Of course, my gut instinct is just that. I think that is really what most everyone is going by. That includes economists and others who are vastly more knowledgeable about economics than I am. We just do not know what the future holds. There are way too many moving parts that interact with each other in unpredictable ways that nobody can take into account all of it. Even if someone could do that, so many events are outside of our lived experience that we cannot fathom what they would look like.
In this century alone we have experienced events that were unprecedented and caught most everyone off guard. Hardly anyone thought there would be a nationwide housing bubble before 2008. Historically, there had only been local housing bubbles and they usually only affected the areas they occurred in. The housing market in Miami had no correlation with the housing market in Phoenix until it did. How many thought in 2019 that there would be a pandemic? Some had warned about the dangers of a potential pandemic before, but not many believed that it would come from a coronavirus. As we all know, that is exactly where it came from.
All this is incredibly agonizing. There are dangers out there, but we have no way of knowing what they are with any degree of certainty. We can try our best to prepare, but that often means fighting the last battle. That has its place when it comes to avoiding repeating past errors, but it is of limited use in dealing with new problems.
What is the upshot of all this? There is no uniform way of doing things. Whether it is dealing with wars, pandemics, economic downturns or any other kind of problem, dynamism is a necessity. What works in one situation does not necessarily work in a different situation and can even be harmful. For example, 10 years ago, the US needed more stimulus spending. Instead, we got spending cuts, which helped delay the recovery from the financial crisis. Inflation and budget deficits were concerns when they should not have been. Today, the situation is reversed. Inflation now is a problem, unemployment is very low and further stimulus spending is not desirable. With interest rates going up, governments will have a much harder time cutting taxes or raising spending without any offsets, as the recent experience of the UK has shown.
Each crisis has to be addressed differently because it will have its own causes. There may be a few common denominators, but the root causes and the proper response will likely differ markedly. For example, the financial crisis was a problem that involved banking. The downturn caused by the pandemic had nothing to do with banking. Dealing with the financial crisis meant dealing with banking while dealing with the pandemic did not.
Dynamism is essential not just for economics, but plenty of other areas, too. Take foreign policy. Sometimes, US involvement is necessary while other times it is not. For example, arming Ukraine and sanctioning Russia is absolutely valid. The US is doing a good job on those fronts and should continue to do so. In contrast, staying in Afghanistan forever was not something we should have been doing. Sometimes, military intervention is necessary and other times it is not. Invading Afghanistan initially was justified while invading Iraq was not.
It strikes me as the height of hubris and arrogance for someone to suggest that a certain approach always works. It annoys me further hearing people argue that believing the same thing is always good or always bad is the only way to have any real beliefs. I will say that anyone wedded to hard, fast rules that they think should always be used no matter what has no business being in a position of authority. The world is way too complex for that to not end poorly.
With respect to specific policy implications, I am not suggesting any here. As I said, for example, stimulus spending has its place, but is not always needed. Almost every policy idea can have its place. Very few things are inherently bad or good. For those who believe certain things always should be done, that is a very unsatisfactory answer, but it is the right answer in my view.
It would be nice to have a short, simple list of things that always work. It would be great to know that when there is a war you do X, when there is a recession you do Y and when there is a pandemic you do Z. Even better would be knowing that if we just did A, B and C, all of those things would never happen again. It would mean we have control over events and can predict the future. Unfortunately, that is not how it works. We humans hate that uncertainty and want to believe we have control over things, but we really do not.
Again, I am not writing any of this out of hopelessness or despair. While I would not call myself an optimist, I am not a pessimist either. I really have no idea about the future of much of anything. I long ago threw in the towel when it comes to being a prognosticator. Some might think that is taking the easy way out, but I think it is the opposite. It would be easy to make all kinds of predictions and pretend like I actually knew what I was talking about. That seems to be what most people do. To each their own I guess, but I’ll pass.
I understand that policymakers and leaders of all sorts have to have plans of some kind. In a way, the economy runs on people making predictions about the future. For example, businesses make all kinds of investments based on where they believe things are headed. Pick your favorite invention and it probably happened because someone thought people would like it and want it. Obviously, that should and will continue because it has to for progress of any sort to be made. It is good for leaders to try to have goals and contingency plans in case things do not work out even though there are limits to what they can do.*
As individuals though we really need to have some humility about what we know. The truth is we know very little about where things are headed. There will be all kinds of events, big, medium and small that will happen over the years and decades that will affect our lives and the lives of others. We just have no way of knowing what they will be or when they will happen. We can try to make educated guesses, but they are just that. The only thing I can say with any bit of certainty is this: the more confident someone is in their ability to predict things, the less confident you should be in them.
*In the off chance that anyone in any major leadership position (business, government or non-profit) were to ask me for advice, I would tell them there is nothing wrong with trying to make plans and map out the future, but to do it with humility and be willing to shift gears quickly if the situation calls for it. Jay Powell, if you’re listening, please give me a call. I’m a fan of yours and appreciate what you’ve done, but stuff like this makes me worry. We need to talk.