Tuesday, November 3, 2009

Fire prevention

In a recent article Lord Skidelsky, who is Emeritus Professor of Political Economy at the University of Warwick, made the following comments on Keynes, forecasts and economic models:

"Keynes’s major contribution to economic theory was to emphasize the “extreme precariousness of the basis of knowledge on which our estimates of prospective yield have to be made.” The fact of their ignorance forces investors to fall back on certain conventions, of which the most important are that the present will continue into the future, that existing share prices sum up future prospects, and that if most people believe something, they must be right.

This makes for considerable stability in markets as long as the conventions hold . But they are liable to being overturned suddenly in the face of passing bad news, because “there is no firm basis of conviction to hold them steady.” It’s like what happens in a crowded theater if someone shouts “Fire!” Everyone rushes to get out. This is not “irrational” behavior. It is reasonable behavior in the face of uncertainty. In essence, this is what happened last autumn."

I think the implications for pension actuaries are clear - we need to spend much more time on fire prevention.

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