Economists vs the zero barrier

January 25, 2011

USA-FED/Anyone involved in financial markets on a day-to-day basis will be familiar with bits of jargon like “breaking the psychological barrier”, “passing key resistance levels,” and even “magic numbers”.

While academics might argue if such things exist, market players put a lot of weight (and money) on the way certain financial instruments, indexes and currencies seem to behave near a certain number – usually a round figure.

Economists, looking months and years into the future to predict the path of entire economies, could well declare themselves immune to the superstitions of daily market movements.

But they too are victims of the psychology of round numbers – or to be precise, zero.

Take Tuesday’s shock preliminary UK GDP figures, which at -0.5 percent came well under even the most pessimistic forecast for +0.1 percent growth.

It’s always easy to say in retrospect, but there were some clues that a below-zero figure might have been on the cards. PMI surveys two weeks ago showed Britain’s service sector, which makes up the bulk of the private economy, declined unexpectedly in December, as did the construction sector. Retail sales figures for last month were also dire.

Still, no economist was willing to break through that zero threshold – and not for the first time.

We know now that the UK entered recession in the second quarter of 2008, and at the time some forward-looking indicators like the PMIs were indeed pointing to a downturn of some sort.

But in our June 2008 UK poll of economists, from 170 quarterly data entries there was only one prediction for any quarter of contraction in 2008 or 2009.

Only when it was clear that the real economy was tanking well below zero did economists slash their forecasts accordingly, much as traders will tell you a currency or stock movements become more fluid after a key resistance level has been broken.

Tuesday’s shock GDP number could be dismissed as a statistical foible, a preliminary figure that’s bound to be revised up once the Office of National Statistics gets the full picture. That’s a familiar yarn, but some economists aren’t sure.

Richard Barnwell from RBS, better than most at predicting the recent movements of the UK economy, had some frank words to say about economists’ reaction to the GDP data:

“It would be arrogant to assume that all the underlying weakness in the data will get revised away because the ‘ONS have got their numbers wrong’. Economists have to face up to the fact that we got our forecasts wrong.”

That zero is a psychological barrier for economists is clearly part of the problem, especially in an age where austerity, sovereign debt crises and renewed commodity price volatility will only complicate the economic outlook further.

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