Bayes Theory in Economics and Economic Forecasting

In response to a recent post in Real World Economics, I set out my views on the application of Bayes Theorem to economics and economics forecasting.

It’s not really related to how I use Bayes Theorem, but then maybe I am unorthodox or maybe I simply don’t understand it and made up my own version of it which is quite likely. I do that.

I tend to focus on the Bayesian idea of how much we should change our mind on rough order probabilities in the light of new information, rather than obsessing on how precise the probabilities are before and after new information. My priors are rough and ready approximations. And for me a good Bayesian approach is one where we are open to new information and adjust our views appropriately, rather than obsesses about roulette wheel like prior and post probabilities. Knightian Uncertainty insights can still be used to assign rough probabilities that then adjust in the light of the new data. Or indeed we can say we don’t know. But sometimes we have to act and saying “we are from Barcelona and know nothing” is not possible. In a battle you have to shoot or not shoot sometimes…

Philip Tetlock’s work on Expert Political Judgement suggests we are not good at forecasting, experts especially; mainly because most of us only use one lens (are Hedgehogs rather than Foxes who know many things in Isaiah Berlin’s terms) and because we don’t admit error and therefore cannot learn from it. Nor I would add do we adjust our forecasts in the light of new data very appropriately. We are over-committed to our prior forecasts.

So to me a healthy use of Bayesian Theorem in economics would be around say Brexit, a very Knightian situation in its lumpy political and economic aspects. At the time of the Referendum I think I assigned about a 35% probability to a Wrecking Ball Scenario aka Hard Brexit with no plan. (I had three other possible scenarios as per Peter Schwartz scenario based futuring). As time has passed I have raised that to about 50% in the light of government incompetence and absence of any apparent plan…if they suddenly next week came out with a brilliant and credible plan my % probability of disaster would plummet..Bayesian Adjustment…

Now I am not using these %s in precise terms like odds on the roulette wheel, that if we ran Hard Brexit a 100 times in parallel universes, 50 would turn out disastrous (and yes I define disastrous as say 10% below trend line growth in GDP by 2029 say) but following Tetlock’s idea that we should test our forecasting by assigning rough probabilities so that over many forecasts of many different things, we can refine our judgment using fine grained %s of our confidence level in our forecasts, rather than binary: Brexit = success vs Brexit = disaster…Such a pity my current Brexit example is 50/50 so ok may it 55/45 or whatever. 🙂

Finally I like to use what I call Reverse Bayesian-ism: “What information would make you change your mind?” (rather than how much should you change your mind in the light of  new information.) This is a good test of what I call Positional Fundamentalists: people whose views/forecasts are so rigid that no information, even in theory if it existed, would make them change their mind. The supporters of a certain US President often fail this test when I apply it. Brexiteers often come close…

Anyway, as a loose Bayesian, I am open to changing my mind in the light of any argument or evidence that you may offer to show I am full of it. I am often mistaken…how about you? 🙂

About creativeconflictwisdom

I spent 32 years in a Fortune Five company working on conflict: organizational, labor relations and senior management. I have consulted in a dozen different business sectors and the US Military. I work with a local environmental non profit. I have written a book on the neuroscience of conflict, and its implications for conflict handling called Creative Conflict Wisdom (forthcoming).
This entry was posted in Academic Conflict, Brexit, Conflict Humor, Conflict Processes, Conflict Statistics, Economic Conflict, Philosophy of Conflict, US Political Conflict and tagged , , . Bookmark the permalink.

2 Responses to Bayes Theory in Economics and Economic Forecasting

  1. Charlie says:

    very interesting … I left a comment at rwer and again thanks for an intelligent and informative response to that issue on rwer

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