Skip to main content

The only thing New Yorkers found themselves digging out from this week was the hype. Instead of one of the "largest blizzards in the history of New York City," as Mayor Bill de Blasio had predicted, the city that never sleeps was forced by authorities to stay home for a routine weather event.

How could the forecasters have been so wrong? The technical answer, as provided by meteorologists, was that most forecasters predicted the path of Monday night's storm using a European computer model, rather than one developed by the U.S. National Weather Service. The European version had proved more reliable in recent years – just not this time.

Luckily, this was a forgivable error, since the only thing the authorities could be accused of was an excess of caution. That did not stop the U.S. media, which had sensationalized the storm warnings to the maximum, from humiliating forecasters and authorities for their epic failure.

A similar predictive failure, but with much costlier consequences, rocked global banks and hedge-fund managers this month when the Swiss central bank suddenly announced it would no longer peg the franc to the euro. The Swiss currency immediately shot up by 30 per cent.

For years, currency and derivatives traders had been making one-way downward bets on the franc. They used the same risk management models, with minor tweaks, that led them to sleepwalk into the 2008 financial crisis. Because the models assigned such a low probability to such a big swing in the franc's value, they had a false sense of assurance. The result was that banks and investors lost billions of dollars in minutes.

The New York snowstorm that wasn't, like the Swiss currency storm that was, are reminders that sophisticated computer models used to predict the future are useless in the face of the unpredictable. Instead of seeking a false assurance in the models, it's better to prepare, to the extent possible, to weather any storm Mother Nature or man dishes up.

Black swans are "large-scale, unpredictable and irregular events of massive consequence," as defined by the author who popularized the term in a 2007 book. Given their unpredictability, says Nassim Nicholas Taleb, the solution cannot lie in developing better predictive methods. Yet, economists and central bankers spend their days trying to do just that.

That doesn't mean we should do away with economic forecasts. They can offer useful guidance and tools for policy-making. But their shelf life is extremely short. Robust policy – such as sustainable public finances or effective bank regulations – must be designed to withstand black swans.

The precipitous slide in oil prices that is wreaking havoc in many countries comes as close as any other recent economic development to meeting the definition of a black swan. No one saw it coming and it has revealed emperors' nakedness in Russia, Venezuela and other petro-states.

Surprisingly, oil's decline is revealing the hidden strengths in Canada's economy and public finances. Despite the hit to federal tax revenues from Western Canada's weaker economy, Central Canada's ability to pick up the slack underscores the strength in economic diversity.

The Parliamentary Budget Officer calculates that, even if oil stays at $48 (U.S.) through to 2020, the net negative impact on federal finances would amount to less than $5-billion annually – on a budget approaching $300-billion. Of course, the PBO's forecast is only as good as the assumptions it is based on.

Still, according to Mr. Taleb's categorization, Canada's economy displays elements of "antifragility." Like a living organism, economies have self-healing properties. The adjustment to lower oil prices will be painful for some, but it could help make our overall economy more resilient.

Trying to smooth this adjustment – for example, with more accommodative monetary policy – is an arguably warranted response. But no one should be naive about the risks.

"Stifling natural fluctuations masks real problems, causing the explosions to be both delayed and more intense when they do take place," Mr. Taleb wrote in a more recent book, Antifragile: Things That Gain From Disorder. "As with the flammable material accumulating on the forest floor in the absence of forest fires, problems hide in the absence of stressors, and the resulting cumulative harm can take on tragic proportions."

For Canada, a housing crash might be the next black swan. But, for now, it's just the elephant in the room.