In a follow up to Part I, looking for predictive factors to the current economic mess, the Federal Reserve Board of San Francisco came out with Part II. In part one, I mentioned my fear that bureaucracies are always reactive and addressing the previous crisis. Part II actually does a good job of highlighting the lack of predictive power of most factors that have been proposed:
Our results yield a plausible set of estimates for the severity of the crisis across countries. That is, we find that Iceland and Estonia were hit more severely in 2008 than, say, China. However, we have less success in linking crisis severity to its causes. We examine over 60 factors that have been advanced in the literature as potential causes of the 2008 credit crisis, but few emerge as robust predictors of its severity. Indeed, we find only one variable–the size of the equity market run-up prior to the crisis–that is a robust predictor of crisis severity. Other equally plausible variables fail to perform well, such as the magnitude of real estate price appreciation or the quality of the regulatory environment. Since early warning models must predict both the cross-country incidence of crises as well as their timing, our analysis bodes poorly for the success of such models.
I actually view this as a positive…the FRBSF is at least looking forward and recognizing the difficulty of predicting, something that bureaucrats often underestimate.