Saturday, October 27, 2012

Readings -- UK growth and black swans

FT Alphaville has a nice post on pessimism about he UK economy even after the somewhat good numbers for GDP this week, notably due to the Olympic bounce, and then make a general point on the problem of monetary policy pass-through to inflation in a leveraged, underconfident economy, via Nomura's Richard Koo
No matter how much liquidity the central bank supplies under such conditions, the money will not leave the vaults of financial institutions because there are no borrowers. Hence it cannot stimulate the economy.

The second, really important reading today is Florin Diacu's post in the New York Times on the appalling conviction of seven earthquake scientists for the failure to predict the L'Aquila April 2009 earthquake. There are two things to keep in mind here. The first is that the failure to think in terms of probabilities is, for everyday purposes, not a big problem, although it annoys me slightly. But it has had important consequences in this case. Yep, they said that an earthquake was unlikely. I made a comment on Brad Plumer's post in the WaPo this week when in a discussion of Intrade manipulation of the Romney v. Obama contract, he suggested, as a lot of people have, that Intrade had been wrong on the ACA ruling. In that particular case, Intrade predicted the overruling of the ACA mandate by the Supreme Court with a 80% probability, which gave you a 1 in 5 chance that it won't be overruled. Intrade was not wrong, or at least, the argument that is being made is incorrect.
The general point is really Nassim Taleb's black swan theory, and Diacu alludes to that in his editorial. You can't predict black swans, but you can build robust system that will be able to suffer extreme events. In the particular case of earthquakes, Diacu writes:
We should not fear earthquakes, since most of us will never experience a major one. But we must prepare infrastructure to withstand disaster and learn how to react when disasters do hit.

Note: A New Scientist opinion post argues that the charges were less about the predicition accuracy than with the communication strategy:
Employed by Italy's Major Hazards Committee to assess earthquake risks and communicate them to the government and the public, the seismologists got the science right, but left the job of public communication to a civil protection official with no specialist knowledge of seismology. His statement to the press was, to put it mildly, a grossly inaccurate reflection of the situation: "The scientific community tells us there is no danger, because there is an ongoing discharge of energy. The situation looks favourable." At this point, the seismologists should have stepped in. But they did not, and the message stuck. 
I find it slightly confusing and still don't see why the scientists should be convicted for that. As Arthur Charpentier writes, they should then just say that there will be an earthquake every day: Instead of making a risky forecast, make the one that minimizes the type II error -- failing to predict an earthquake -- while forgetting everything about the type I -- predicting an earthquake when it doesn't happen

Risky prediction
Yay! Safe prediction

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