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.â€
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.â€
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.