BY BEATRICE FALERI 17/03/2015
Why economists failed to anticipate the 2008 global financial collapse has been an unanswered question since 2008. The answer that economist Tim Harford, FT journalist, BBC presenter and author of the bestseller The Undercover Economist gave to the crowd was: ‘They simply could not see it”.
The latest EFS’s event about economics forecasting brought together past, present and future and – of course – an economist of the caliber of Tim Harford. Through a running comparison of the lives of John Maynard Keynes and Irvin Fischer, arguably the two most prominent economists prior to the Great Depression of the 1930s, Harford unveiled the difficulties of predicting and overcoming major shocks in the global financial market.
Prior to the Great Depression, both Keynes and Fischer led incredibly successful lives, using their knowledge and expertise not only to develop macroeconomic theory, but to amass vast fortunes in the stock markets. During the 20s, both became extraordinary rich and respected: Fischer by ‘betting on the margin’ (i.e. profiting from rising interest rates by buying stocks with borrowed money) and Keynes by making short-term aggressive investments. Both were caught by surprise when, in 1929, the stock market crashed and, both risked bankruptcy.
How could the imminent collapse of the world stock market and the most severe economic crisis in human history elude even the greatest contemporary economists? Drawing heavily on the work of Philip Tetlock, Harford offered a simple answer: even, or maybe particularly, experts can be wrong. Given the statistically poor record of most expert predictions, Harford joked, we may be better off investing in chimps instead.
Nevertheless, Hartford explained, there does in fact exist a rare species of ‘superforecasters’: people who can consistently and reliably predict correct outcomes. One particular trait these people share is that they recognize when a forecast can simply not be made. Superforecasters display a psychological trait called ‘active open-minded thinking’ which prevents them from falling into self-confirmation bias.
Returning to the allegory of the lives of Fischer and Keynes, it becomes clear that Fischer did not display the characteristics of a superforecaster: Fischer, as opposed to Keynes, continued believing that the stock market would recover, even as the Great Depression deepened with every passing year. ‘His overconfidence, stubbornness and optimism betrayed him’, summarised Harford: Fischer died poor and humiliated. Keynes, by contrast, went on to cement his place as the greatest economist of the 20th century by establishing the foundations of modern macroeconomics and playing an instrumental role in the design of the post-war Bretton Woods system. Keynes drastically changed his investment strategy and built a larger fortune than the one he had lost in the crash. His motto? ‘When the facts change, I change my opinion’. That, Harford concluded, is an approach we should all adopt.
Media: Listen to an exclusive Perspectives interview with Tim Harford, here.