Who predicted what, when and why

Let’s go back to March 3, 2009.  Here’s Paul Krugman:

As Brad DeLong says, sigh. Greg Mankiw challenges the administration’s prediction of relatively fast growth a few years from now on the basis that real GDP may have a unit root — that is, there’s no tendency for bad years to be offset by good years later.

I always thought the unit root thing involved a bit of deliberate obtuseness — it involved pretending that you didn’t know the difference between, say, low GDP growth due to a productivity slowdown like the one that happened from 1973 to 1995, on one side, and low GDP growth due to a severe recession. For one thing is very clear: variables that measure the use of resources, like unemployment or capacity utilization, do NOT have unit roots: when unemployment is high, it tends to fall. And together with Okun’s law, this says that yes, it is right to expect high growth in future if the economy is depressed now.

But to invoke the unit root thing to disparage growth forecasts now involves more than a bit of deliberate obtuseness.

And here is Greg Mankiw’s reply:

Paul Krugman suggests that my skepticism about the administration’s growth forecast over the next few years is somehow “evil.” Well, Paul, if you are so confident in this forecast, would you like to place a wager on it and take advantage of my wickedness?

Team Obama says that real GDP in 2013 will be 15.6 percent above real GDP in 2008. (That number comes from compounding their predicted growth rates for these five years.) So, Paul, are you willing to wager that the economy will meet or exceed this benchmark?

And here’s what I wrote, 5 years later:

Krugman wisely decided to avoid this bet, which suggests he’s smarter than he appears when he is at his most political. In any case, the actual 5 year RGDP growth just came in at slightly under 6.3%. That’s not even close. Mankiw won by a landslide.

In January 2011, Tyler Cowen wrote a book entitled “The Great Stagnation.”  So far Tyler’s hypothesis has proven correct. (Oddly, the media often refer to Larry Summer’s stagnation hypothesis, which (AFAIK) came much later.)

In 2013 Tyler made a bet with Bryan Caplan, that unemployment would not fall quickly back to 5%:

Tyler just bet me at 10:1 that U.S. unemployment will never fall below 5% during the next twenty years.  If the rate falls below 5% before September 1, 2033, he immediately owes me $10.  Otherwise, I owe him $1 on September 1, 2033.

Readers of my blog know that I would have agreed with Bryan.  Tyler Cowen responded by pointing to reasons why these bets are not a good idea:

Bryan Caplan is pleased that he has won his bet with me, about whether unemployment will fall under five percent.  I readily admit a mistake in stressing unemployment figures at the expense of other labor market indicators; in essence I didn’t listen enough to the Krugman of 2012.  This shows there were features of the problem I did not understand and indeed still do not understand.  I am surprised that we have such an unusual mix of recovery in some labor market variables but not others.  The Benthamite side of me will pay Bryan gladly, as I don’t think I’ve ever had a ten dollar expenditure of mine produce such a boost in the utility of another person.

That said, I think this episode is a good example of what is wrong with betting on ideas.  Betting tends to lock people into positions, gets them rooting for one outcome over another, it makes the denouement of the bet about the relative status of the people in question, and it produces a celebratory mindset in the victor.  That lowers the quality of dialogue and also introspection, just as political campaigns lower the quality of various ideas — too much emphasis on the candidates and the competition.  Bryan, in his post, reaffirms his core intuition that labor markets usually return to normal pretty quickly, at least in the United States.  But if you scrutinize the above diagram, as well as the lackluster wage data, that is exactly the premise he should be questioning.

As I’m the only one in this exchange fessing up to what I got wrong, and what I still don’t understand, and what the complexities are, in a funny way…I feel I’m the one who won the bet.

I agree with Tyler’s skepticism regarding the utility of public bets; they oversimplify a very complex set of issues.  They also subtly imply that greatness is a function of not being “wrong” about particular questions.  I’d argue that one doesn’t become a truly great scientist until one’s views have been partially discredited.  That means people are taking your ideas seriously, and pushing them to the point where they are no longer intellectually progressive.  (Think Copernicus, Newton, Einstein, Darwin, etc.)

However, as someone who agreed with Caplan, I don’t entirely accept the implication of Tyler’s final sentence.  I can’t speak for Bryan, but here are the views I’ve expressed:

1. Cycles in unemployment are largely caused by nominal wage stickiness, and unemployment will usually revert back to the natural rate, which tends to be fairly stable in the US (but not completely stable).

2. The US is entering a Great Stagnation, where 3% NGDP growth will be the new norm, measured RGDP growth will also slow sharply, but of course it’s not clear what RGDP actually is, because it’s not clear what economists mean by the term “price level.”

3. The Labor Force participation rate has historically been unstable, unlike the natural rate of unemployment, responding to demographics, welfare reform, disability insurance, prison incarceration, etc., etc., etc.)  Wage stickiness doesn’t explain this.  But Tyler was also skeptical of how far Bryan and I pushed the wage stickiness concept.  Since our view is that wage stickiness explains changes in the unemployment rate, but not the LFPR, Bryan winning his bet is at least as small point in favor of the sticky wage model.

4. Fiscal austerity would not slow growth in 2013, a claim Paul Krugman contested.  I was right and Krugman was wrong.

5. Repealing the extended unemployment benefits in early 2014 should have modestly increased new job creation, by boosting the supply of labor.  This would be true even if NGDP growth (i.e. AD) did not accelerate.  Paul Krugman also contested this claim.  Again, I was right.  Job growth in 2014 was substantially above the 2010-13 rate, despite very modest growth in NGDP. Of course Krugman has been right about many things, especially when he agreed with market monetarists.  Thus he has criticized the mainstream conservative prediction that “easy money” would lead to high inflation.

6. I’ve consistently predicted that unemployment would fall faster than the Fed thought, and that NGDP growth and inflation would be less than the Fed thought.  That’s actually sort of threading the needle, as faster falling unemployment would normally be associated with faster than normal NGDP growth.

Despite the fact that I’ve recently ended up being right more often than wrong, I think the importance of specific predictions is overrated.  If I had been blogging in 2006-09 I would have been wrong about lots of things, because the market was wrong about lots of things.  The economy is very hard to predict, and hence I’ve been lucky.  More important is the reasoning process used.  Here is how I’ve approached this:

1. For low NGDP growth and inflation predictions I’ve relied on market forecasts, which generally seemed more bearish than Fed forecasts.

2. For the Great Stagnation, early on I noticed a “job-filled non-recovery”, which many people oddly called a jobless recovery.  The unemployment rate fell sharply despite anemic RGDP and NGDP growth (for a recovery period).  So I reasoned that if RGDP growth was only 2.0% to 2.5% during a period of fast falling unemployment, then the trend rate of growth must be really slow.  So far I’ve been correct (and I hope my prediction is soon refuted, for the sake of the economy.)

3. For the unemployment compensation issue I relied on basic theory, and on previous studies of the effect of UI on jobless rates.  Back in 2008, Brad DeLong predicted higher unemployment as a result of a very small increase in benefits under President Bush.  It seemed to me that people like Krugman were abandoning mainstream economics for ideological reasons.

4. Standard theory, pre-2008, also implied that the monetary authority drove AD, and that fiscal policy would only impact growth by shifting the AS curve.  I saw no reason to abandon the standard view.

5. As far as wage stickiness and unemployment, my views were shaped by many factors, including my study of the Great Depression, and the fact of wage stickiness documented by many studies.  I also relied upon the strong theoretical implication that if nominal wages are sticky then nominal GDP shocks will lead to volatility in hours worked.  As far as the unemployment rate recovery predicted by Caplan, I relied on both theory (Friedman/Phelps) and evidence—the fact that the US natural rate seems fairly stable at around 5%. That’s the best I could do, and in this case I was right.  But if I’d lived in Western Europe in the late 1970s and early 1980s, I would have been wrong and Tyler would have been right, as the unemployment rate jumped sharply, and never went back down (except in a few countries like Germany, and even then only much, much later.)

Market forecasts are the best we can do.  I suggest that readers pay less attention to who predicted what, and more on the reasoning process behind their predictions.  Occasionally people will get lucky and nail a prediction that the markets missed (think Roubini, John Paulson, Shiller, etc.)  But when you look at their overall track record it’s clear that luck was involved; no one can consistently predict the macroeconomy. Nor should we focus on who has the most impressive mathematical model. Instead we should focus on who has a coherent explanation for what is occurring, an explanation that is consistent with well established theory, and that can be applied to a wide range of cases.  I hope market monetarism is one of those coherent explanations.

PS.  I just returned from the Warwick Economics Summit, and was very impressed by the Warwick students.  I would especially like to thank Ibraheem Kasujee, who helped arrange the visit.  It was good to get out of the Puritan States of America for a few days, and attend a student ball where drinks are served to 18 year olds.  At Bentley even the faculty can’t drink a glass of wine at the Holiday Party.  And Bentley just banned smoking everywhere—basically telling the smokers (who used to huddle outside in the cold) to go away, we don’t want you here.  This university is only for PC puritan paternalists.  (On the plus side, our students do get good jobs.)

I had planned on being home for dinner on Monday, but instead (due to snow at the Boston airport) I was 30 miles north of Reykjavik (at 11 pm Iceland time), in the middle of nowhere, standing in a cold wind with no hat on, looking straight up at a zillion stars in the sky–and a few northern lights as well.  But now I’m back and have a huge amount of catching up to do. (Here’s my earlier unexpected layover in Iceland.)

For readers who didn’t get their fill of Krugman bashing here, I also have a new Econlog post.



36 Responses to “Who predicted what, when and why”

  1. Gravatar of Britonomist Britonomist
    10. February 2016 at 08:44

    Speaking of Tyler Cowen, I think this recent post should be of particular interest to you: http://marginalrevolution.com/marginalrevolution/2016/02/what-is-the-meaning-of-a-strong-yen-and-japanese-negative-ten-year-yields.html

    P.S glad you enjoyed your trip to Warwick, that is actually my alma mater!

  2. Gravatar of Brian Donohue Brian Donohue
    10. February 2016 at 09:20

    Great post.

  3. Gravatar of E. Harding E. Harding
    10. February 2016 at 09:53

    “And Bentley just banned smoking everywhere—basically telling the smokers (who used to huddle outside in the cold) to go away, we don’t want you here. This university is only for PC puritan paternalists.”

    -My only problem with this is that they didn’t do this five decades ago.

    Good post. Productivity (especially in manufacturing) is stagnant, America is only a percentage point away from full employment, male labor force participation is collapsing, and Trump triumphs even better than predicted in the polls. Life is good.

    “Market monetarists are like those Irish monks that upheld classical learning during the long dark ages. In this case the long dark age of macroeconomics.”

    -Excellent quote.

    And this stagnation (2011-today) is not the same thing as the 1973-today stagnation.

  4. Gravatar of jonathan jonathan
    10. February 2016 at 11:09

    You make a good point. Here is how I would phrase it: economic models do not typically make very different unconditional forecasts of variables, and thus comparing the unconditional paths of a particular variable tells us little about whose model is right. Instead, models make different conditional forecasts, or equivalently different forecasts about the joint behavior of variables.

    Thus rather than simply asking who predicted variable X correctly, look at their reasoning to see whose model of the joint behavior of (X,Y,Z,…) is most consistent with what happened.

    Take the Krugman-Mankiw example. Note that Krugman was not arguing about whether GDP growth would be high or low; he was critiquing Mankiw’s model of a unit root in GDP growth. Krugman was pointing out that log GDP satisfies:

    dY = d(Y/N) + dN

    And that d(Y/N) has a unit root, and dN does not. Thus Krugman’s model predicted that *if* dY was low in 2009 – 2012, this would be because d(Y/N) was low, not because dN was low, and that dN should be higher than its historical rate.

    Incidentally, I agree with Krugman’s model, but our model has been mostly wrong: the employment rate has not recovered very much since 2009. This has been really surprising to me.

  5. Gravatar of E. Harding E. Harding
    10. February 2016 at 11:35

    “Incidentally, I agree with Krugman’s model, but our model has been mostly wrong: the employment rate has not recovered very much since 2009. This has been really surprising to me.”



  6. Gravatar of ssumner ssumner
    10. February 2016 at 13:54

    Thanks Britonomist, I had a bit of trouble following that argument. Negative IOR on excess reserves need not hurt bank profits, if combined with positive IOR on required reserves.

    Thanks Brian.

    Jonathan, Good comment.

  7. Gravatar of Gary Anderson Gary Anderson
    10. February 2016 at 14:08

    I honestly believe that even non economists (who would want to be miserable like an economist) can clearly see that market monetarism as a tool to follow what is really happening in the economy is a lot more enlightening than just watching inflation. But, I also believe, (and most economists want to keep their jobs so they will never admit it)that the Fed misprices risk, blows bubbles and then cuts those bubbles down.

    That is playing a different and unfair game that market monetarists don’t want to play. The Fed not only plays a different game, but it owns the ball, the rules, the referees, (except the super bowl referees. Not sure who owns them), and knows when the game starts and will be over.

  8. Gravatar of ninive ninive
    10. February 2016 at 14:11

    Glad you liked the Warwick Economics Summit, this time on site (I was the one you sent a video to for the WES back in 2011 😉 )

  9. Gravatar of Gary Anderson Gary Anderson
    10. February 2016 at 14:11

    I have been to the Bentley campus. It was for my son’s MBA graduation. He was 22. He was smarter than his dad, but has conspiratorial blindness like many smart people. 🙂

  10. Gravatar of Tom Brown Tom Brown
    10. February 2016 at 14:13

    Scott, an interesting post. Here’s a quote from a physicist that IMO makes for a fun comparison:

    “One of the most disappointing things about the Standard Model in physics is that it doesn’t fail empirical tests [1]. When you have a model, the failures point out where there are things you don’t understand.”

    That overlaps a bit with what Tyler and you write, but the glaring difference is “it doesn’t fail empirical tests.” LOL! From what I can tell, economists would be delighted to have such problems!

  11. Gravatar of Garry Garry
    10. February 2016 at 14:15

    Saying “Cycles in unemployment are largely caused by nominal wage stickiness..” is like saying airplane crashes are caused by the ground being in the way.

  12. Gravatar of TravisV TravisV
    10. February 2016 at 14:45

    Good Lord, GIGANTIC decline in five-year expected inflation on the FRED website to 0.93%. 5-year, 5-year forward inflation expectation has also fallen dramatically to 1.49%.

  13. Gravatar of Britonomist Britonomist
    10. February 2016 at 14:49

    Scott, but what do you make of the Yen rising?

  14. Gravatar of Kevin Erdmann Kevin Erdmann
    10. February 2016 at 15:18

    Don’t get too worried, TravisV. Those are just market prices, which can be distorted. The Fed has many internal models for this sort of thing, and the important thing right now is the subset of those models that shows inflation rising.

  15. Gravatar of Scott H. Scott H.
    10. February 2016 at 15:20

    To give Krugman’s actual view on fiscal spending its due…

    Fiscal austerity slows growth, not necessarily absolutely, but relative to any non-fiscal austerity. It’s a definitional thing that can’t ever have a demonstrable counterfactual.

  16. Gravatar of E. Harding E. Harding
    10. February 2016 at 15:38

    Scott, what is fiscal austerity?

  17. Gravatar of Matt Moore Matt Moore
    10. February 2016 at 15:44

    When I was doing my undergraduate at Oxford, we had an exchange programme with Dartmouth. I will never forget the sequence of facial expressions one of those students produced when, arriving for his first college formal event, he was handed a large glass of white wine by the then Warden, Dame Avril Cameron, and told to ‘drink up’.

  18. Gravatar of TravisV TravisV
    10. February 2016 at 15:50

    Ha ha, Kevin, ha ha!

    Good new post by Lars Christensen, however, little mention of NGDP:


    David Beckworth also had a good post entitled: “The Fed Did Not Make A Mistake In December”

    Also Tea Partier Scott Grannis has admitted he was wrong to deny monetary policy was too tight and is now advocating QE.

  19. Gravatar of Benjamin Cole Benjamin Cole
    10. February 2016 at 16:59

    Nice post but…jeez 3% NGDP growth ahead and the audience reaction “la-de-dah”?

    Dudes, that is a terrible number, and I do not believe it is baked in the cake.

    QE, FICA tax holidays, wipe out SSDI and VA disability, and legalize push-cart vending and illegalize property zoning.

    And another question: why do we accept the fact that the Fed has to buy bonds from the 22 primary dealers, and then create reserves in the commercial bank accounts of those 22 dealers?

    Why not the Fed sets up its own desk and buys bonds directly, without creating reserves. There is no need for the ridiculous interest on excess reserves.

    You would think from various discussions about the Fed, that the legal fictions that surround the Fed are laws of physics. They are not. They are all fabrications of man and can be altered.

  20. Gravatar of Tom Brown Tom Brown
    10. February 2016 at 17:08

    Scott, David Glasner’s latest is interesting, and perhaps relates to your comment here:

    “Instead we should focus on who has a coherent explanation for what is occurring, an explanation that is consistent with well established theory, and that can be applied to a wide range of cases.”

    I’d say, is “well established” in economics something to necessarily be proud of? Isn’t RBC “well established” or the microfoundations that Glasner addresses in that post? Religions are also “well established” but that doesn’t get them very far. It’d be nice if “well established” meant “has proven to be empirically useful over a certain predefined scope.”

  21. Gravatar of Tom Brown Tom Brown
    10. February 2016 at 17:14

    Scott, I tried to correct my bad 1st link there, and my attemp disappeared. Just go to his latest entitled “There Is No Intertemporal Budget Constraint”

  22. Gravatar of Jared Fisher Jared Fisher
    10. February 2016 at 17:17

    I’m sure you can anticipate what Caplans reply would be. People can use “good reasoning” to support any position. While bets may be an imperfect measurement, they are at least an objective way of testing our beliefs. And while one bet may not give a firm answer, someone who is far more likely to be correct is a useful tool when deciding what beliefs are true. I would rather listen to the guy who is consistently correct but with bad reasoning rather than the guy who says good sounding stories but is never correct. I’m surprised you think otherwise, considering how you have often railed against the media for perpetuating good narratives even after the facts don’t support the story.

  23. Gravatar of Tom Brown Tom Brown
    10. February 2016 at 17:32

    … and BTW, I’m not poo-pooing all of econ as trash. It’s just that the phrase “well established” doesn’t seem as impressive as perhaps in other fields: like “evolution is well established” or “Newtonian mechanics is a well established approximation with a wide scope of validity.” (and yet we know it’s not valid outside that scope). I’m sure there are lots of well established bits (supply & demand curves?), but econ appears (to an outsider like me) to be still in its infancy, with nothing as grand and sweeping as Newtonian mechanics (let alone General Relativity). Perhaps “microfoundations” will end up in the dust-bin of history someday, but it seems pretty well established right now, doesn’t it?

    And thus I conclude my Dunning-Kruger rant.

  24. Gravatar of ssumner ssumner
    10. February 2016 at 20:04

    Garry, That’s right. There’s nothing you can do about either the ground or sticky wages, so don’t crash the airplane and don’t crash NGDP.

    Thanks Travis.

    Britonomist, People say the yen is a safe haven currency, I don’t know enough to comment.

    Scott, You said:

    “It’s a definitional thing that can’t ever have a demonstrable counterfactual.”

    That’s not Krugman’s view (or are you being sarcastic–in which case I agree.)

    Jared, You need much more than good reasoning, and the stories I criticize don’t even have good reasoning, they are full of fallacies when you take a close look. Empirical evidence is also very important. Prediction is fine, but overrated.

    Tom, You said:

    “I’m sure there are lots of well established bits (supply & demand curves?), but econ appears (to an outsider like me) to be still in its infancy, with nothing as grand and sweeping as Newtonian mechanics”

    This is a common misconception. Economics is not in its infancy, it’s like an old man. It’s just as advanced as the physics of earthquake prediction or the physics of coin toss prediction or the physics of weather prediction or a million other types of actual, useful real world physics. In other words, what looks like infancy is just the complexity of the systems being analyzed. I don’t know why people don’t get that, it’s such an obvious point.

  25. Gravatar of ssumner ssumner
    10. February 2016 at 20:05

    Matt, Good story.

  26. Gravatar of Tom Brown Tom Brown
    11. February 2016 at 00:21

    Scott, you write:

    “In other words, what looks like infancy is just the complexity of the systems being analyzed. I don’t know why people don’t get that, it’s such an obvious point.”

    Well maybe I am missing that. But imagine this: we select at random a group of notable physicists to propose a means of getting a manned mission to Mars. We tell them they stay locked up until they come up with something, and they’ll be held accountable if their plan fails. Do you think they could come to some broad agreements?

    Now imagine the same for meteorologists and/or climate scientists and their mission is to estimate the path of a hurricane, or perhaps to estimate the number and location of hurricanes during one season. Do you think they could come to some broad agreement?

    Now imagine a group of notable macroeconomists selected at random to devise a completely new monetary system, tax system and economic policy. Or perhaps their mission is to propose a path of recovery in the depths of a bad recession. Or perhaps they are to evaluate the definitive causes of that recession and write a group report with recommendations about what government policies to change. Or to build some forecasts with confidence bounds and a means of evaluating the empirical success of their models. Will you guys ever get out of that room, or is it a life sentence?

  27. Gravatar of Tom Brown Tom Brown
    11. February 2016 at 00:29

    … actually, a president Trump might just do that. And if you guys fail, you get waterboarded… or worse. Maybe you and your families go to gulags. Kind of like Stalinist Russia, but without quite as much central planning.

  28. Gravatar of ssumner ssumner
    11. February 2016 at 07:00

    Tom, Going to Mars is easy–it’s all empty space between here and there. Predicting a hurricane 1 month ahead is hard, and no I don’t think climate scientists would agree. Economists can predict GDP a month ahead better than applied physicists can predict hurricanes a month ahead.

  29. Gravatar of Tom Brown Tom Brown
    11. February 2016 at 10:23

    Scott, OK, fair enough. I take your word for it.

  30. Gravatar of Tom Brown Tom Brown
    11. February 2016 at 10:26

    Although, I’ll remind you I’ve put some predictions on the table. We’ll see how I do against the experts.

  31. Gravatar of david david
    12. February 2016 at 02:34

    krugman on 2013:

    “What we should have realized, but I didn’t – at least not fully – was that the sequester just wasn’t that big relative to the economy.

    there were other things going on – such as a sharp slowdown in the rate of fiscal tightening at the state and local level

    According to the IMF’s estimates (which are similar to other estimates), there was indeed fiscal tightening in 2013 – but the pace of that tightening was no faster than it had been in 2012 or 2011. So there is no reason we should have seen a sharp growth slowdown”

  32. Gravatar of ssumner ssumner
    13. February 2016 at 12:51

    David, That’s been refuted many times, here and elsewhere. In calendar 2013, the deficit plunged by about $500 billion, nearly falling in half. Facts are stubborn things.

    And if Krugman wants to revise his view of 2013, then why isn’t he revising his view of 1937? Maybe because there was a recession in 1937? In other words, the facts are made to fit the theory.

  33. Gravatar of Bob Murphy Bob Murphy
    14. February 2016 at 17:50


    After reading this post I realize I did not have a complete mental model of your views. (Perhaps this does not surprise you.)

    I thought your big picture view was that wages were sticky, and that’s why aggregate demand mattered so much. Because if real wages were artificially high, then unemployment was above the natural rate, and so real output was too low.

    But apparently that’s not at all how below-trend NGDP growth ends up causing less-than-sustainable RGDP growth.

    I’m guessing that if I have misunderstood your views on such a fundamental level, then a bunch of other people have too, so might be worth elaborating.

  34. Gravatar of ssumner ssumner
    14. February 2016 at 19:29

    Bob, No, I do think wage stickiness is why nominal shocks matter.

  35. Gravatar of Bob Murphy Bob Murphy
    15. February 2016 at 07:33


    OK, so is the following close to your view then?

    “It was incredibly tight monetary policy that is largely to blame for the sluggish recovery from the 2008 crisis. However, at this point the unemployment rate has probably dropped to (close to) the natural level, and real economic growth for now is at its potential. If we wanted faster real growth, we would need to adjust supply side factors by removing silly regulations, cutting certain tax rates, etc.

    However, we are in a precarious situation given the state of monetary policy. If and when the next demand shock hits, we would find ourselves in another sluggish recovery. That’s why we should adopt NGDPLT, not because it would do anything for us right now–we have already fully recovered–but to avoid a future unforced error.”

    Is that close, Scott?

  36. Gravatar of E. Harding E. Harding
    15. February 2016 at 17:10

    Bob, IMHO, that sounds exactly like what Scott Sumner would type, especially the second paragraph.

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