How ‘black swan’ events are ruining economic predictions – #podcast

Hi it’s manika your support means a lot to us here at the decibel and your feedback matters too and we want to know what you think of the podcast so we’ve set up a quick survey where you can tell us your thoughts and as a thank you

There’s a chance to win some prizes we’ll tell you how at the end of today’s episode back in January 2020 the Bank of Canada was predicting slow but steady growth for the economy but then covid hit everything shut down and the economy fell into chaos something similar happened last year

When Russia invaded Ukraine economic forecasts can be incredibly important especially for companies and governments but some experts say they’re becoming less and less accurate Todd Hirsch has been an economist for around 30 years and he spends a lot of time trying to predict the economy today he tells us why this isn’t working

As well as it used to how so-called Black Swan events are changing things and what that means for how we plan for the future I’m Anna Karam and Wilms and this is the decibel from the Globe and Mail Todd thank you so much for joining me oh

It’s a real pleasure to be here thank you so let’s just start with the the base question here which is why do we have economic forecasts in the first place like why are they important well forecasting goes back a long way probably to the 50s or 60s when economists started to develop these

Econometric models where you would put in your assumptions and out would come sort of a forecast of what is likely to happen next and it’s all sort of based on historic patterns so as economists got better and better at doing this and more mathematically and inclined a whole

Sort of industry grew up around economic forecasting to the point where we’re at today where people put a lot of emphasis on these forecasts can you give me a sense of like like who would be using these forecasts who finds this actually valuable well they report these forecasts in the

News so a lot of you know Canadians just driving around listening to the news they’ll hear oh you know this bank is forecasting real GDP growth to be you know four percent this year or one percent the Bank of Canada of course uses forecast uh to give guidance to uh

Institutions other governments what the economy is likely to do or their best assumptions about what the economy is going to do it’s used a lot by companies that are doing budgeting and so it’s important in that respect that the company that is putting together their budget or their projections on sales or

For the next year that they have some idea what the economy is likely to do okay so important for companies I imagine it’s also important for governments though so so how would a government use an economic projection like a GDP projection how would they use that for example in their budget

Yeah governments are obviously I mean they use these forecasts quite intensively when they’re putting together their budgets give them a sense of what Revenue tax revenue they might expect in the coming year if the economy is going to uh project it to do really well or if it’s projected to do poor

That will give the government a better sense of what they can expect for revenues and also spending when we think about employment insurance or when we think about other benefits and supports that governments pay that’s a cost to governments the what the economy is going to do or likely to do will give

Them some guidance and how to plan around that okay and so Todd you said these forecasts are essentially based on a set of assumptions about what what might happen so how accurate are these forecasts well we’re getting worse and worse at doing it and it’s not a reflection of the mathematical abilities

Of the forecasters it’s not a problem with the model the problem is that in the 21st century we are bombarded by increased numbers of what we might call Black Swan events these events that come out of nowhere that almost by their definition are unpredictable but they have a massive impact either you know

Plus or minus to the economic forecast the very best example would be what happened in March of 2020 when the world was plunged into a pandemic nobody really saw that coming even though you know people for years have been sort of warning of a pandemic coming no one knew

The timing of it so it really through forecasts out the window and it’s not just covet it’s all sorts of other things it’s Russia’s invasion of Ukraine it’s more severe and more violent and destructive weather events these things are impossible to predict with any Act accuracy and as a result economic

Forecasting has been worse we’ve we’ve gotten these forecasts wrong more often I I want to get into to how how they are worse and you know what we can do about that but maybe let’s just stick with some of these examples that you’ve thrown out here Todd can you can you

Walk me through one I guess like let’s look at one of these Black Swan events as you say how exactly would it have messed up economic forecasts well we can take the Russian invasion of Ukraine uh when that happened when the tanks rolled across the border almost instantly financial markets swooned

Because there’s instability and there’s questions about you know military conflict a ground war in Europe so you know investors were anxious markets would would fall but the other thing that happened is commodity prices went through the roof and that’s because both Ukraine and Russia are really important producers and suppliers of agricultural

Commodities and in the case of Russia energy Commodities so we saw oil prices you know Spike through the roof we saw wheat prices in canola prices but it through the forecast out the window because suddenly these commodity prices spiked oil particularly so for here in Alberta when we’re trying to make a

Forecast Energy prices are really important nobody really was able to factor in Russia’s invasion of Ukraine and what that did to oil prices what about an example like with with natural disasters you mentioned that a little bit earlier so we’re seeing obviously more natural disasters these days

Because of the effects of climate change and I’m thinking about something like you know the BC floods that happened in 2021 how would something like that change things the the flood in BC in 2021 hurricane Fiona on the east coast of Canada and in late 2022 even some of the ice storms

That hit Canada and the major airports these events because they bring a lot of economic activity grinding to a halt very quickly it can depending on how long it goes on it can have a very negative impact on the economy the floods in in BC a great example because

That was weeks or even months before some of those Transportation corridors were back up and running so it’s really disruptive to the economy activity what that normally would be happening is not able to happen so it leads to a big drop a sudden drop in economic activity at

Least in the short run okay so this things are can kind of throw things into disarray you talked about how forecasts are getting more inaccurate Todd so let’s focus on that like how inaccurate are forecasts now can we can we get into some of the numbers well it’s hard to pinpoint how accurate

Or inaccurate they are because we can always revise a forecast and I think what’s happening now are companies or their maybe economics teams they’re being asked to revise forecasts more frequently as situations develop and that’s fine but you know taken to the Absurd extreme we could be revising a

Forecast every hour with new information and you’re never really going to be wrong but then it’s not much of a forecast at all it’s just sort of a real-time read of what the economy is doing and maybe that’s what we need to think about rather than locking in a

Forecast you know and giving people this false sense of confidence that what the economy is going to do in in several months or several years let’s let’s focus a little bit then on how the economy has been behaving recently uh because you said you know these forecasts are based on how the

Economy has responded historically so how is it behaving these days well still with a lot of unpredictability another great example sort of a recent situation here in Canada is late 2021 early 2022 the Bank of Canada was basically saying we’re going to keep interest rates low what

They did not expect any you know inflation pressures but these inflation pressures in 2021 did sort of come out of nowhere they caught everybody including the Bank of Canada by surprise and as a result the Bank of Canada did have to start raising interest rates quite aggressively in early 2022 and

Right up until you know sort of they’ve they’ve leveled off now but throughout 2022 we saw a big increase in interest rates by the Bank of Canada and it’s not that you know the Bank of Canada I don’t want to suggest they got it wrong they

Reacted to a new information when it was available it’s just that back in 2021 I think they left Canadians with a bit of you know again false confidence this idea that interest rates are going to stay long for an extended period of time they spoke of that with a lot of

Confidence and a lot of Canadians sort of made decisions based on what the Bank of Canada was saying that interest rates aren’t going anywhere but then they did so so what does that mean for people like who were listening to these forecasts like how does that impact the

People in Canada who are making these decisions for themselves well this is where you know there’s some really sad stories I remember listening on the radio a story of a um a woman a young mother who had listened to the advice of the advisors around her she’d done all the right

Things she had sort of done the homework and listened to what the Bank of Canada was saying and at the time in 2021 you know go with a variable rate mortgage because you’ll get a better rate and interest rates aren’t going anywhere but then they did so in this case this woman

Even though she did her research she was still caught off guard so this is where you know I talk about leaving people with a sense of false confidence we always have to remember anything could happen a forecast is really only based on the assumptions that we put in it if

There is an event like inflation spiking out of nowhere like Russia’s invasion of Ukraine we have to remember that those kinds of events can throw these forecasts off so so we never really want to have all that much confidence in a forecast we need some healthy skepticism

It’s good to say okay here’s what is likely to happen but we always have to keep in mind Anything could happen and we have to be prepared to react to that we’ll be back in a moment so is the economy behaving the same way that it has in the past like is looking

To the past I guess still helpful for us in this moment well that’s a whole other issue when we look at the economy in the 21st century it doesn’t really resemble uh the economy of the mid 20th century in in many ways at all we could get into all

Of the new industries that we’re seeing for example artificial intelligence cyber security cryptocurrencies all of these things are having an impact on the global economy that didn’t exist 50 years ago when econometric modeling and you know looking at the patterns of how an economy reacts when all of those were

First established the economy is not behaving as it did in the past especially the labor market and this has a lot of economists scratching our heads because when we look at the past you know certain patterns of the labor market are quite predictable but this

Time you know and it might be because of covet it might be some of the psychology of workers has changed fundamentally there’s also social and demographic things going on but the labor market is not really behaving in the same way that it has previously so we’ve recently

We’ve had a lot of really good job numbers coming out in Canada and this is sort of Defying Gravity because we’ve seen interest rates increase this is supposed to be putting the brakes on the economy at this point we would probably expect fewer jobs being created we’d expect the unemployment rate creaking

Higher we’re not seeing it at all and I think there are some reasons for that I think there’s some reasons why consumers have not been responding to higher interest rates like they would have in the past in the past they would very quickly have you know stop buying homes

Or you know bought fewer car or consumer spending would be dampened by the increase in interest rates but we didn’t really see that coming out of covet not in the same way not in the predictable way that we would have seen it in the past so it’s left us a little bit

Confused and a little bit I’m curious as to why the economy especially the labor market is behaving in a different way yeah so so Todd you’re saying it kind of were in in almost like an unprecedented State here but I I guess I want to push back

On this a little bit because there have always been Wars and health scares and Bank collapses so so what’s different about the way that things are happening now yeah you’re absolutely right none of the things that we’re seeing today are you know especially new maybe covid I mean

We haven’t been through anything like that since you know 1918 not in the same way not in the same Global pandemic but you’re right war is not new weather events are not new inflation is not new I think what is maybe different in 2023 is the speed at which these uh

Disruptive events can disrupt a global economy we are more connected globally than we were 20 years ago or 50 years ago for sure we trade more in Commodities than we did 50 years ago so when Russian oil exports are cut off that has a really immediate impact on

Oil prices around the world like it happens literally in hours these events because we are more connected electronically we’re connected through trade and Global Commerce it’s not that they’re new but they’re having a bigger impact on the global economy and a more immediate impact so we feel these shock

Waves more suddenly and and maybe more extreme I mean I understand that the connectedness factor that that seems fairly straightforward but can you just explain the immediacy a little bit to me like how has learning about these events so quickly really affected things well take for example the the collapse

Of Silicon Valley Bank it was a Friday morning that happened by Friday afternoon the entire world knew about this and everyone was starting to look at their Bank a little bit differently and wondering boy I wonder if my bank is going to be the next one that you know

To go through this so say 50 years ago we would have seen Bank collapses but especially because it happened on a Friday people wouldn’t have even heard about this they might have read about it in a newspaper over the weekend or but because of uh the connectedness and the

Immediacy of global media everyone at least everyone sort of in the banking and finance World everyone knew about the collapse of Silicon Valley Bank within a few hours and it had a more immediate and a bigger impact on the financial markets so because of all of these things you know like we said

There’s always been Wars there’s always been bank failures but today these these blacks Juan events these unforeseeable events not only are they making forecasting more difficult but they are presenting companies and individuals with a sort of a wider array of possible scenarios that could play out and this

Is where I’m thinking a role for an economist we might be better serving people if in fact rather than trying to come up with our pinpoint forecast for GDP but rather help individuals and help companies think their way through any number of scenarios that could befall

Them and how they are going to react to that is is that something that’s that’s attainable that that predictors could actually start doing then well in some ways a lot of economists we do do this and when I was the chief Economist at a financial institution out

Here in Alberta we always did our forecast contained a low a medium and a high case scenario recognizing that we have not a lot of confidence that these you know event different events could happen the problem with that is people still want to say well what’s the base case you

Know give us a number they still sort of want to default to what is the number even if we do try to say well we have to be conscious there is a possibility of a low case or a high case scenario so in a lot of ways we do try already to present

A bunch of different scenarios that could play out but maybe it’s in the wording that we need to repackage this a bit so as not to leave people with this again the sense of false confidence that it’s going to be the medium case the the base case scenario which is what we call

It sometimes so so how to think things can things can differently going what’s something that we could actually kind of tangibly do here to make it better I think maybe what we could do is look at some of the Black Swan events in recent history the geopolitics for

Example and maybe extrapolate that into the future and say well what does it look like for this industry or for this company if we are to see intensified geopolitical tensions around the world what is the scenario that could play out without trying to be predictive and

Saying here is what is going to happen but rather say well here are some possible scenarios can we think our way through as an industry or a company or a government can we think our way through what would be our response if this happens or if that happens and instead

Of just one forecast number look at a broad array of different scenarios and and sort of focus on what is our response to each of those and I think that’s the gist of what I’m I’m talking about lately is not that we shouldn’t try to look into the future but we

Should try to be less confident or we should be less confident about these pinpoint forecasts that these econometric models produce because they’re not likely to be right we need to look at all of the possible scenarios and be able to react to any of those hmm Todd this is really interesting thank

You so much for joining me today it’s been a real pleasure thank you for having me Thanks for listening today so about that survey on the decibel we want to know about you and what you want to hear on the show just go to the decibelsurvey.ca fill it out and as a thank you you’ll be automatically entered to win one of three grocery gift cards for Loblaws

Worth a hundred dollars again that’s the decibelsurvey dot CA we can’t wait to hear from you That’s it for today I’m mainika Ramen Wilms our interns are wafael Reyes Andrew Hines and Tracy Thomas our producers are Madeleine white Cheryl Sutherland and Rachel Levy McLaughlin David Crosby edits the show Adrian Chong is our senior producer and Angela pacenza is our executive editor thanks

So much for listening and I’ll talk to you tomorrow

Economic predictions can be incredibly important for companies and governments trying to plan for the months and year ahead – and that ripples down to individuals trying to budget as well. But some experts worry that the forecasts are becoming less and less accurate.

Todd Hirsch has been an economist for around three decades. Today, he tells us why forecasts aren’t working as well as they used to, how so-called ‘black swan’ events are changing things, and what that means for our ability to plan for the future.

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