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NASSIM TALEB: Here’s Why Governments Always Miss Their Own Budget Deficit Targets – Business Insider

The pdf is actually called Econfragilize

(The book isn’t actually out until late November, but Taleb posted this appendix, entitled WHERE MOST ECONOMIC MODELS FRAGILIZE AND BLOW PEOPLE UP, on his website today.)

The problem is that the economic data forecasts the government uses to plan its budget around – like where unemployment will be a year from now, for example – are pretty much taken as a given, instead of looked at as mere likelihoods with some given probability.

When the government plans its budget this way, it tends to underestimate the damage when things get worse than they initially expected.

Taleb illustrates how this mistake causes governments to continually underestimate the size of their budget deficits and miss their targets:

Say a government estimates unemployment for the next three years as averaging 9 percent; it uses its econometric models to issue a forecast balance B of a two-hundred-billion deficit in the local currency. But it misses (like almost everything in economics) that unemployment is a stochastic variable. Employment over a three-year period has fluctuated by 1 percent on average. We can calculate the effect of the error with the following:

Unemployment at 8%, Balance B(8%) = −75 bn (improvement of 125 bn)

Unemployment at 9%, Balance B(9%)= −200 bn

Unemployment at 10%, Balance B(10%)= −550 bn (worsening of 350 bn)

The concavity bias, or negative convexity bias, from underestimation of the deficit is −112.5 bn, since ½ {B(8%) + B(10%)} = −312 bn, not −200 bn.

In this example, Taleb identified that since unemployment typically varies around 1 percent, one should take estimates of what happens when it goes 1 percent lower than expected and when it goes 1 percent higher than expected.

via NASSIM TALEB: Here’s Why Governments Always Miss Their Own Budget Deficit Targets – Business Insider.

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