Our government is very optimistic about the economy

[Kurt_and_Hunter]

I posted something about the just-released bank stress-test criteria earlier, but it was probably confusing and inaccessible. (I did not paraphrase it from Paul Krugman, BTW. I don't think he had commented on the stress metrics yet at the time of that post, though he has since.)

We are beginning a process of examining the banks in light of down-side scenarios to see how well they could handle a crisis. The stress test was described to the NYT a few days ago as: "The stress tests will use computer-run “what if” situations to estimate what would happen to each bank under Depression-like conditions, with unemployment surging to 10 or 12 percent, for example, or home prices dropping 20 percent further, Treasury and Federal Reserve officials said. Fed officials emphasized that these hypothetical events were “highly unlikely” to occur."

But the test metrics published don't include what most of us would call "Depression-like conditions" or "highly unlikely" scenarios.

For instance, here is a chart of the stress-test housing projections. The green line is what the government says is likely. The red line is the stressful "depression-like" case.

But I don't know anyone who thinks the green line is very realistic and most of us would be somewhat relieved if the red line was as bad as it got.

This isn't to say the government is stupid. It points to something more systemic: Economic forecasts are conservative and consensus/average forecasts even more so. Economists in aggregate almost NEVER predict anything very dramatic, yet dramatic things happen all the time. (downside and upside)






If chart not showing, it's at the link:

http://www.calculatedriskblog.com/2009/02/stress-test-house-price-scenarios.html