Short Term Serial Correlation and Long Term Mean Reversion sound rather heavy. And so they should. They were conceptualised by statisticians, after all; people who make economists sound normal. Yet an understanding of these two phenomena helps explain why the myth that politicians can and do solve real problems continues.
Short Term Serial Correlation emerges because people like to see patterns. Random events are never evenly distributed; some areas will manifest more incidents than others. Geographically, there may be a larger concentration of accidents, or geniuses, or Stephens in one locality; chronologically, there will be more crimes, or jackpots, or bankruptcies in one month than another. For some of these there may be real causes (a criminal has moved into the area, thus triggering a local crime wave) but very often apparent rises or falls in frequency are just the results of random coincidence.
Long Term Mean Reversion is the inevitable “return to form". If there is no cause for these clusters, in the long run they will even out. The average reasserts itself. Because there was no reason for the cluster of incidents, it is not sustained and everything returns to normal. All very dry stuff, you might think, and blindingly obvious. Except that this duel-phenomenon may explain why interventionism is so popular. Take two examples:
- A number of traffic accidents in a short space of time lead to a public outcry and a demand that something be done to improve safety in what is, apparently, a dangerous stretch of road. Local people focus not on the 10 year average but the tragedies of the past 12 months. Action is called for and local councillors step in. Money is spent changing the road layout, building speed humps or erecting a camera. The following year the number of accidents falls (returns to the long-term average) and both councillors and residents claim it is a success.
- The economy goes into a bit of a slide. Shares fall and unemployment rises. Worried citizens demand that something be done to prop up asset values and protect jobs. The government – ever eager to please – steps in with a lot of expensive and headline-grabbing measures. After a period, economic activity recovers its upward momentum. Government officials are quick to point out that the recovery results from their own policies. Put like this, the significance of these phenomena should be obvious.
The natural instinct of people to cry that “Something must be done" very often leads to policies that appear to have the desired result. This perpetuates the belief that politicians can make a difference and that without them the world would rapidly go to hell in a hand basket.
