ECONOMICS FORECASTING:A Nobel prize-winning economic forecaster, Sir Clive Granger may be self-effacing but his views on the Irish and US economies are insightful, writes Michael Casey
IT IS almost a law of life that truly talented people are the most self-effacing. Take Prof Sir Clive Granger, a true academic and a modest seeker of truth for its own sake.
Granger's modesty is innate and can be seen in his choice of universities: Nottingham rather than the more prestigious Oxbridge, and San Diego rather than Harvard or Yale. Nevertheless, he has helped to put both of his chosen universities in the first rank for research in applied mathematics. As a young man he wanted to specialise in meteorology, but he suffered from a stammer and wandered into statistics because he had trouble pronouncing, "meteorology".
In keeping with his character, his engagements on a recent visit to Ireland were a secondary school, Mercy Mounthawk, and the Institute of Technology, both in Tralee. Both audiences were awed by his presentations.
Self-effacing he may be, but Granger's contributions in the field of econometrics - the application of mathematics and statistics to the study of economic and financial data - have helped model-builders everywhere, including the Central Bank of Ireland and the ESRI. Granger Causality and Cointegration - for which he was awarded the Nobel Prize - are part of every model-builder's tool-kit. Granger Causality is a method for testing whether one variable actually causes movements in another. Cointegration is a technique for ensuring that a correlation between variables is robust. Both methods are important to ensure researchers pick up important behavioural relationships and not just spurious correlations.
Within days of winning the Nobel Prize he was inundated with calls seeking his advice on various economies, but the role of guru does not sit well with him. Nevertheless, during his recent visit, he had some interesting insights on the US and Irish economies.
On the US economy he doesn't doubt that there is a recession and he is inclined to believe that the costs of the war in Iraq are an important contributory factor. However, despite the almost inexplicable sub-prime fiasco and bank collapses, he believes the real economy remains fundamentally sound. The recession, he feels, may not last too long - history shows that recessions tend to disappear fairly quickly after wars end. Another encouraging sign is that financial flows from abroad are still healthy and, despite everything, Americans seem to be getting wealthier, especially in California.
He is not unduly worried about America's twin deficit problem. After all, it took former US president Bill Clinton only four years to eliminate the fiscal deficit and the weakness of the dollar may in time help to lessen the balance-of-payments deficit.
The financial sector is of course a mess, but it may not damage the real economy all that much. Main Street has a habit of bouncing back even though Wall Street has taken leave of its senses. Financial regulation clearly needs root and branch reform and the Fed should supervise more closely the corporate governance of banks, he believes.
In an interesting aside, Granger expressed the view that the collapse several years ago of the Long Term Capital Fund (LTCM) was due in large part to different funds using similar risk-management programmes. LTCM for example had a contingency plan which involved the disposal of a certain class of asset, but it had no way of knowing that other funds had the same plan. In fact, because of anti-trust legislation they were prevented from "talking to" the managers of other funds. Thus, when LTCM had to liquidate some of its assets it found that other agencies were selling off the same kinds of assets. Prices fell and it was impossible for LTCM to restore its liquidity. To avoid this kind of co-ordination failure from occurring again, Granger believes that the Fed should take on an advisory role in this type of situation. It is infinitely preferable to prevent financial crises than to clean up after they have occurred. The sub-prime debacle testifies to that.
The Irish economy may not suffer unduly if the recession in the US proves to be shallow and not too prolonged. Because of Ireland's membership of the Euro area, however, policy instruments are limited. In general, he believes that governments do not have very much control of their economies. More control might be needed. For example, the Central Bank could talk to the banks and use moral persuasion.
Granger is essentially a pragmatist. He is not hide-bound by theory or by ideologies. On social partnership in Ireland his view is that if it works, then fine. However, it would not be easy to measure its influence because of the problem of the counterfactual. How would wages have developed in the absence of social partnership? In any case the social partners should recognise the difficulties facing the economy and agree to play their part.
A pay freeze sounded reasonable as long as it was for a short period. The lower paid could be exempted from a pay freeze on grounds of equity, but also because the marginal propensity to consume of this group is high. Therefore, consumption could be stimulated or at least prevented from falling.
On fiscal policy, he feels that Ireland's low tax regime should be maintained if possible. He is a Keynesian and believes that a deficit might stimulate activity although the extent of this might be limited because of our high propensity to import. Despite what Barack Obama says about taxing US multinationals overseas, he could, if elected, modify that proposal. If not, it could be a serious problem.
Government borrowing should not be regarded as a problem if it is used to build capacity which in turn will generate future income. In the longer-term Ireland should probably try to prepare for the relocation of its manufacturing base to lower-income countries. Moving into the information economy does not happen automatically but involves original research, development and innovation. This is why mathematical and scientific education is so important. The high failure rate at secondary school level in mathematics is a warning which should be taken very seriously .
On model-building and econometrics, fashions can and do change. There was a time when economic theory was sacrosanct and model-builders and data analysts had to respect it at all costs. Nowadays, if the data does not support the theory, it is better to go with the story the data is telling.
Models are particularly useful for forecasting and the performance can be tested against actual outcomes. This sort of regular comparison can help to tweak the model in question and improve its performance. Model-based policy simulations can also be helpful but are more difficult to test against reality. Simple time-series models can be as good as large structural models, but in general the latter, if they contain good dynamic features, will tend to give better forecasts and richer advice.
Data-mining, composite indicators and human judgement are all respectable nowadays. If they work, they work, period. Granger stressed that one of the great advantages of San Diego University was the reluctance to set up committees. This allowed much more time for research and serious thinking. Perhaps this approach might well be adopted in this country.
