Extreme volatility during the global financial crisis complicated economic forecasting, leading to large errors that underline the need for better modelling methods and new approaches for making and presenting projections, according to an OECD report. OECD forecasts during and after the financial crisis: a post-mortem says that the Organisation’s economic projections under-predicted the depth of the collapse in activity in 2008-09 and over-estimated the pace of recovery in recent years. The degree of forecasting errors seen over the 2007-12 period is similar in size to that seen around the first oil shock in the 1970s.
The OECD report analyses the key factors driving forecast errors and draws lessons that can be used to improve its forecasting and analysis. “We have learned a lot from the crisis,” OECD Chief Economist Pier Carlo Padoan said during a launch event today in London with the London School of Economics. ”We have taken steps to improve short-term forecasting models, construct better indicators of financial conditions and explore the risks around our forecasts more systematically,” Mr Padoan said.
The analysis of forecasting offers new insight into how the global economic crisis impacted different countries. Forecast errors were larger in the economies that are most open, in terms of trade and finance, suggesting that globalisation has increased exposure to external shocks and made countries more connected than in the past. Errors in economic projections were also larger in countries with the most stringent pre-crisis labour and product market regulations, suggesting weaker resilience than in more deregulated economies.
The large and negative errors on growth in countries with weak banking systems, confirm that financial factors need to be given more weight in economic models. “The repeated deepening of the euro area sovereign debt crisis took us by surprise, because of the stronger-than-expected feedback between banking and sovereign weaknesses, and this influenced our over-estimation of projected growth during the early stages of the recovery,” Mr Padoan said.
Strong moves toward fiscal consolidation have been blamed by some for weaker-than-projected growth, but the OECD finds that this holds true only in some years, and only when Greece is included in the analysis. “The OECD did not underestimate fiscal multipliers,” Mr Padoan said. “It was the repeated assumption that the euro crisis would dissipate over time, and that sovereign bond yield differentials would narrow, that turned out to have been the most important source of error.”
The review of forecasting is part of a wider effort at the OECD to better understand the global crisis and use it as a source for the development of New Approaches to Economic Challenges (OECD).