Unpredictable

In his latest Washington Post column Robert Samuelson confesses the awful truth: economists just aren’t that good at predicting the future course of the economy.

You knew it all along: Economists can’t forecast the economy worth a hoot. And now we have a scholarly study that confirms it. Better yet, the corroboration comes from an impeccable source: the Federal Reserve.

The study compared predictions of important economic indicators — unemployment, inflation, interest rates, gross domestic product — with the actual outcomes. There were widespread errors. The study concluded that “considerable uncertainty surrounds all macroeconomic projections.”

Just how large were the mistakes? The report, though written mostly in technical jargon, gives a straightforward example:

“Suppose . . . the unemployment rate was projected to remain near 5 percent over the next few years, accompanied by 2 percent inflation. Given the size of past errors, we should not be surprised to see the unemployment rate climb to 7 percent or fall to 3 percent. . . . Similarly, it would not be at all surprising to see inflation as high as 3 percent or as low as 1 percent.”

And unlike, say, meteorology, economic forecasting isn’t getting much better:

Clearly, much economic forecasting is guesswork. Worse, the gap between prediction and reality may be widening. The study — done by David Reifschneider of the Federal Reserve and Peter Tulip of the Reserve Bank of Australia — found that forecasting mistakes had worsened since the 2008-09 financial crisis.

An interesting question (which the study did not ask) is whether economic forecasting has improved in the past century. In the 1920s, with no computers, forecasters relied on random statistics: freight car loadings; grain harvests and prices; bank deposits. Today, forecasters employ elaborate computer models that scan dozens of statistical series describing the economy. Yet the predictions seem no better.

I think there are a number of reasons for this. First, the political stakes can be very high. Confirmation bias can influence an economist to make predictions simply unsupported by the numbers.

Second, winds typically do not change their course to take advantage of the potential for leveraging a weather forecast into new profits but people do respond to policy changes. The conditions today may be drastically different than those built into the economic models.

Third, the data aren’t very good. Our ways of measuring behavior aren’t particularly accurate for all sorts of reasons. Barometric pressure doesn’t lie but people do. For some things the Internet has made an enormous difference. The Billion Price Project provides data in real time or near real time previously unavailable.

Finally and in my opinion most importantly, fine tuning is just impossible. Many, many economists predicted that the real estate bubble would burst but not nearly as many could tell you precisely when or how high prices would go. In other words they could tell you the general direction but not the precise direction or force. That’s the equivalent of telling you that the wind will blow sort of from the west but not whether it’s from the west, northwest, or southwest or at what force.

14 comments… add one
  • Ben Wolf Link

    The forecasting is always based on the assumption that market economies will autonomously trend toward full employment. So they determine their desired outcome and then build the forecast around achieving it.

  • michael reynolds Link

    Any system with a substantial human component is unpredictable. Unpredictable a hundred years ago, unpredictable now, unpredictable forever.

  • TastyBits Link

    Credit backed money does not function the same as hard money, but if credit backed money creation is limited, it can function approximately the same. Hard money is to credit backed money as Newtonian physics is to Einsteinian physics.

    It seems that few economists understand this simple truth. MMT does seem to grasp the difference, but even the gold standard brigade do not seem to understand that classical economic theories cannot work when credit backed money is scaled up and out.

    Nonetheless, they will continue to spout nonsense, and this nonsense will continue to be the conventional wisdom. Once they are able to predict the past, they will try to apply it to the future, and they will continually fail.

  • CuriousOnlooker Link

    When is Hari Seldon when you need him?

  • Gray Shambler Link

    Which is another reminder of central planning’s central failure, lack of knowledge, as inefficient as it is, the free market is still much better at allocating resources, because it’s more nimble and self corrects more quickly.

  • Ben Wolf Link

    “Which is another reminder of central planning’s central failure, lack of knowledge, as inefficient as it is, the free market is still much better at allocating resources, because it’s more nimble and self corrects more quickly.”

    If free markets self-correct quickly, then government actions cannot interfere.

  • Gray Shambler Link

    Cannot, or Must not?

  • Ben Wolf Link

    Cannot, or Must not You don’t understand the difference in the words?

  • When is Hari Seldon when you need him?

    More than one economist, Paul Krugman among them, has said that he or she was inspired to get into economics after reading the Foundation trilogy.

  • steve Link

    You beat me to it Curious. One of my early reads and still one of the best.

    “the free market is still much better at allocating resources, because it’s more nimble and self corrects more quickly.”

    For the price of potatoes and other commodities, sure. For services, sure. For the entire market, especially a banking crisis? Not so much. Way too many examples of help needed from the central government.

    Steve

  • Guarneri Link

    “Way too many examples of help needed from the central government.”

    Heh. Interesting that some of our worst performing industries – banking, insurance, medicine, and education – receive so much government “help” in the form of subsidy, regulation and regulatory capture, and being the dominant purchaser.

    Funny that.

  • michael reynolds Link

    Predicting human behavior is as impossible as exceeding the speed of light. The only way it can be possible to predict human behavior with any accuracy is if free will does not exist. It’s not about imprecise measurements, it’s not about politics, it’s an impossibility if free will exists. Impossible by definition.

    In fact that’s rather the point of a free market, no? Because if human behavior could be predicted then markets could be managed. If we knew that in three years we’d need a million pairs of Uggs shoes, we could have a centrally planned economy. But we can’t. Which is why the free market is necessary.

    And of course it goes beyond the problem of free will. Can we predict whether there will be a major earthquake in California or a series of devastating hurricanes in Florida? Can we predict an eruption of some new plague? No. Can we predict the arrival of a disruptive new technology?

    This isn’t science, this is alchemy. It’s never, ever going to happen. Never. You’re like a bunch of mini-Newtons who should be spending their time on calculus but can’t accept that you will never turn lead into gold.

  • Ben Wolf Link

    Michael,

    The justification for keeping government out of markets is that we’re all rational, that we know everything we need and want at every point in time until the death of the universe. That means assuming humans are deterministic and predictable which, as you’ve probably noticed, incoherently makes the case for central planning.

  • michael reynolds Link

    Ben:

    I think if humans are entirely rational then either a completely free market, or a centrally planned market, can be justified in that either approach will work.

    If man is rational hence predictable then the only objection to a centrally-planned economy is a purely ideological one, an essentially emotional objection, which rather undercuts the notion that man is rational.

    On the other hand, if man is rational then a free market will work because a billion rational people will shape the market rationally and thus be predictable, which would result in a market so efficient that the ups and downs would be eliminated and we would always know precisely how the market would respond to various exigencies.

    To counter the notion that man is rational I offer a single word: lottery. There are plenty of others, but lottery does the trick since it involves these allegedly rational creatures spending seventy billion dollars a year against an infinitesimal chance of profit. It is the least profitable way to spend a dollar.

    Libertarians seem convinced that homo sapiens is perfectly rational so long as no government intervenes. This is self-refuting because if man were perfectly rational then men would not desperately crave the power that comes from being part of a government.

    Life is a shifting Venn diagram of DNA, environment, free will and random chance, but one school of thought after another tries to deny one or more parts of that matrix. Which is why ideologies are inevitably bullshit and the fate of homo sapiens is to muddle through without ever really solving the puzzle. The notion that we can accurately predict an economy which now includes essentially the entire human race, an economy which is the system of everything, is mad. The best we can hope to do is keep calm, and carry on.

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