In its recent 77th annual report, the Bank for International Settlement (BIS) sings a humble song: “Economics is not a science”, and adds “at least not in the sense that repeated experiments always produce the same results”. True. It seems that at least one of the authors at the BIS has read Mises’ book about “Theory and History” instead of the usual preposterous math-filled articles from the American Economic Review.
The BIS report authors admit that “economic forecasts are often widely off the mark”, and that economics suffers from “inadequate data” and “deficient models”. Very true, but let us add that this is so because it is mainly useless data that are being collected by economists and statisticians when following the Keynesian framework and that it is the wrong models that most economists look at that are the cause of this detrimental state.
The BIS also adds that it is not risk but uncertainty that we have to deal with. True. Menger, Mises, Hayek, Rothbard, and all the other old and new Austrian economists have preached this insight for more than a century by now, but few wanted (or were able) to listen. Instead of acquiring a sound understanding of economics, students of economics have been mistreated by an useless and dangerous avalanche of nonsense that has been thrown upon them disguised as “science” since the time when Paul Samuelson had assumed the role as the law giver of modern “economic science”, and while the “models” have changed — often to the opposite result – the Samuelson attitude of hubris — the pretense of knowledge — has prevailed.
The BIS also says that most policymakers didn’t see the “Great Inflation” of the 1970s coming, and that “virtually no one” foresaw the Great Depression of the 1930s. Just one advice here: Why not just check only a few of Mises’ writings of the 1920s and Hayek’s of the 1970s? It’s all there.
Here now is the quote from the 77th Annual Report of the Bank for International Settlements:
“Economics is not a science, at least not in the sense that repeated experiments always produce the same results. Thus, economic forecasts are often widely off the mark, particularly at cyclical turning points, with inadequate data, deficient models and random shocks often conspiring to produce unsatisfactory outcomes. Even trickier is the task of assigning probabilities to the risks surrounding forecasts. Indeed, this is so difficult that it is scarcely an exaggeration to say that we face a fundamentally uncertain world – one in which probabilities cannot be calculated – rather than simply a risky one.
Economic history is a useful guide in this respect. The Great Inflation in the 1970s took most commentators and policymakers completely by surprise, as did the pace of disinflation and the subsequent economic recovery after the problem was effectively confronted. Similarly, virtually no one foresaw the Great Depression of the 1930s, or the crises which affected Japan and Southeast Asia in the early and late 1990s, respectively. In fact, each downturn was preceded by a period of non-inflationary growth exuberant enough to lead many commentators to suggest that a “new era” had arrived. Similar surprises can be noted at a more micro level. Around the time of the failure of LTCM in 1998, the firm faced price shocks in various markets that were almost 10 times larger than might reasonably have been expected based on previous history. As a result, its fundamental assumptions – that it was adequately diversified, had ample liquidity and was well capitalised – all proved disastrously wrong.
Of course, many will say that our understanding of economic processes has improved thanks to this experience. Yet this is not such an easy proposition to prove. Consider, for example, the typical way in which central bank economists forecast future inflation using econometric models of how wages and prices interact. To do this accurately, at least five questions have to be answered correctly. What is the best way to measure excess capacity in the domestic economy? What is the trend rate of growth of productivity? Are foreign influences limited to import prices alone? Are wages driven by forward-looking price expectations, or by past price developments? If expectations are important, are they influenced by the credibility of central banks or by something else, like actual or even perceived inflation? Each of these questions is currently highly contentious. And when we turn to other economic variables, the degree of disagreement about many equally fundamental issues is just as great.
Indeed, in the light of massive and ongoing structural changes, it is not hard to argue that our understanding of economic processes may even be less today than it was in the past. On the real side of the economy, a combination of technological progress and globalisation has revolutionised production. On the financial side, new players, new instruments and new attitudes have proven equally revolutionary. And on the monetary side, increasingly independent central banks have changed dramatically in terms of both how they act and how they communicate with the public. In the midst of all this change, could anyone seriously contend that it is business as usual? There is, moreover, a special uncertainty in the area of monetary policy. While the commitment of central bankers to the pursuit of price stability has never been stronger, the role played by money and credit is being increasingly debated, against the backdrop of the uncertainty about the inflation process referred to above. For some central banks, and indeed many leading academics, neither money nor credit is thought to play any useful role in the conduct of monetary policy. For others, in contrast, the too rapid growth of such aggregates could be either a harbinger of inflation or the sign of a financially driven boom-bust cycle with its own unwelcome characteristics.
Against this background, neither central banks nor the markets are likely to be infallible in their judgments. This has important implications. The implication for markets is that they must continue to do their own independent thinking. Simply looking into the mirror of the central banks’ convictions could well prove a dangerous strategy. The implication for policymakers is that they should continue to work on improving the resilience of the system to inevitable but unexpected shocks.”
Commentary posted by Antony Mueller