Beating the business cycle

• Author: Johannes Wiegand
• Position: IMF Policy Development and Review Department
• Pages: 214

Page 214

Why do economic forecasters do such a poor job predicting growth? One crucial reason, argues Anirvan Banerji, Director of Research of the independent, New York-based Economic Cycle Research Institute (ECRI), is that they fail to predict the turning points of the business cycle. At a June 23 IMF book forum, Banerji presented his new book, Beating the Business Cycle: How to Predict and Profit from Turning Points in the Economy (coauthored with Lakshman Achuthan), and offered a spirited defense of the "leading indicator approach" to predicting growth.

"The record of failure to predict recessions is virtually unblemished," the IMF's Prakash Loungani concluded in a 2001 study of private sector forecasts. That dismal record makes it all the more remarkable that one organization has constantly bucked the trend.

According to The Economist, ECRI is "the only organization to give advance warning of each of the past three recessions; just as impressive, it has never issued a false alarm."

What accounts for ECRI's success? Banerji credits first and foremost the organization's reliance on an elaborate system of leading indicators to predict turning points in the economy.

This approach has often been belittled as "measuring without theory," but Banerji went to some length to counter this assertion.

He claimed that formal econometric models are not sufficiently flexible to capture turning points of the economic cycle-as illustrated by the work of two well-known econometricians.

In the late 1980s, they created a sophisticated recession probability index, which immediately failed to predict the 1990 recession. Queried as to the reasons why the index had failed, one of the authors replied: "parameter drift."

A better tool kit

Thus, a more robust approach was needed, as the correct projection of turning points of the business cycle could provide crucial information to policymakers and markets.

Banerji insists that ECRI's analysis lives up to this claim. Back in 1950, Geoffrey Moore-one of ECRI's intellectual fathers-created eight leading indicators of revivals and recessions for the U.S. economy from 1870 to 1938. Forty years later, he repeated this exercise for various industrial countries in the second half of the 20th century. To Moore's own surprise, he found that the leading...