The Fed reflects on its bad forecasting

How could they have gotten forecasts so wrong? The Federal Reserve is thinking about it, after some very poor predictive years.

Their conclusion is that the Great Recession was something like a Black Swan.

The collapse in housing prices and its propagation to the economy…. [was] the most likely unlikely bad event.  [emphasis added]

So we can view this as a classic futuring failure, as per Taleb’s model. They glimpsed the future, but saw it as simply too unlikely.  Low probability, high impact.

Self-satisfaction fuels this mindset:

[our] biggest failure was the complacency resulting from the apparent ease of maintaining financial and economic stability during the Great Moderation. 

Alternatively, we can see it as a problem of analysis, rather than one of mental attitude.  Consider the specific missteps the Fed identifies:

Misunderstanding of the housing boom. Staff analysis of the increase in house prices did not find convincing evidence of overvaluation…

A lack of analysis of the rapid growth of new forms of mortgage finance. Here the reliance on the assumption of efficient markets appears to have dulled our awareness of many of the risks building in financial markets in 2005-07…

Insufficient weight given to the powerful adverse feedback loops between the financial system and the real economy. Despite a good understanding of the risk of a financial crisis from mid-2007 onward, we were unable to fully connect the dots to real activity until 2008. [emphases in original]

The knowledge was out there, but we didn’t appreciate it, in other words.  This was an intellectual error.

Ah, but that’s how Black Swans work, murmurs my ventrioloquized Nassim Taleb.   It’s all so clear afterwards.

Let’s leave that argument in suspension as a useful bracket around futuring’s problems, confidence vs analysis.

(link via ZeroHedge; image from krupp)

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