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"Stress Test" Scenarios

By Anonymous

The Obama administration has taken a good deal of heat for the less-than-catastrophic assumptions in its bank stress tests. In the "more adverse" scenario, average unemployment is 8.9% in 2009 and 10.3% in 2010, while housing prices fall 14% in 2009 and 4% in 2010.

While the adverse scenario may indeed be overly optimistic, it's important to note that in constructing the baseline and adverse scenarios, the administration largely relied on the average projections of professional forecasters. In particular:

The "more adverse" scenario was constructed from the historical track record of private forecasters as well astheir current assessments of uncertainty. In particular, based on the historical accuracy of Blue Chip forecasts made since the late 1970s, the likelihood that the average unemployment rate in 2010 could be at least as high as in the alternative more adverse scenario is roughly 10 percent. In addition, the subjective probability assessments provided by participants in the January Consensus Forecasts survey and the February Survey of Professional Forecasters imply a roughly 15 percent chance that real GDP growth could be as least as low, and unemployment at least as high, as assumed in the more adverse scenario.
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Based on the year?to?year variability in house prices since 1900, and controlling for macroeconomic factors, there is roughly a 10 percent probability that house prices will be 10 percent lower than in the baseline by 2010.

The administration was, no doubt, trying to maintain a certain level of objectivity in constructing the stress test scenarios, which, given Treasury's limited resources, was probably a good idea. So whatever you may think about the stress test scenarios, they weren't, as Dean Baker suggests, "rigged" in any way.

Full post as published by Economics of Contempt on April 02, 2009 (boomark / email).