Thinking About Economic Forecasts

Over the weekend, Slate published a short Tim Harford item on the imprecision (and, yet, periodic usefulness) of economic forecasts. We don't put much stock in economists' point estimates (e.g., Q4 GDP will grow at 1.2%), but we do appreciate many of their qualitative and more generalized quantitative arguments. Here are a couple telling excerpts from Harford:

When people discover that I am an economist, they rarely ask me for my views on subjects that economists know a bit about--such as how to respond to climate change or pay less at a supermarket. Instead, they ask me what will happen to the economy.

Why is it that people won't take "I don't really know" for an answer? People often chuckle about the forecasting skills of economists, but after the snickers die down, they keep demanding more forecasts. Is there any reason to believe that economists can deliver?

After crunching a few numbers, Harford draws out the following (somewhat tentative) conclusion:

The new data seem to confirm Kay's original finding that economic forecasters all tend to be wrong in the same way. Their incentives to flock together are obvious enough.

What is less clear is why the flight of the flock is so often thought to augur much--but then, some astrologers are also profitably employed.

The curious thing is that forecasters often have something useful to say, but it is rarely conveyed in the numerical forecast itself on which so much attention is lavished. For instance, in December 2006, forecasters were warning of the risks of an oil price spike, a sharp rise in the cost of credit, and a dollar crash. The quantitative forecasts are usually wrong and not terribly helpful when right, but forecasters do say things worth hearing, if only you can work out when to listen.

We thought this was an apt prelude to Monday's Wall Street Journal story on economists' expectations for the second half of 2008, in which Kelly Evans notes that second-half growth projections have come down significantly from where they were at the start of the year.

Taken together, the upshot of these two pieces isn't that economists' new projections are more accurate than their former ones. (In fact, the tendency to extrapolate makes it very difficult to predict turning points in the economic cycle.)

Instead, the point is that anyone concerned about the near-term future of economic data would probably do better to think in big-picture contextual terms rather than fine-grained statistical ones. The data matter, of course, but more as a dots of color in an impressionist painting: Not especially precise or realistic in and of themselves, but powerful and revealing when arranged together on a larger canvas.

Sources

Tim Harford, "The Wisdom of Crowds?" Slate, August 9, 2008

Kelly Evans, "Economists Expect 2008's Second Half To Be Worse Than First," Wall Street Journal, August 11, 2008

Comments

[johnthebear:]

Sooooo true... "Instead, the point is that anyone concerned about the near-term future of economic data would probably do better to think in big-picture contextual terms rather than fine-grained statistical ones."

To understand the bigger picture think of the context:

We give out a bonus to stimulate buying, which seems to work in the short run, at the same time, lower interest rates causes the dollar to fall... ok, so what is the effect... short term prop-up of the retail economy and a falling dollar that makes exports rise. So far so good. What next?

Think about it... when we export more, and then Europe exports less, then their economy declines along with China, Japan and India who also export less! Not to hard to figure so far...right?

China, Japan and India stock markets are 50% or more off their 52 week highs, reflecting the weak economy there as well as Europe... with me so far?

So what is next? So called forecast ignore the basics and attempt to estimate numbers that do not reflect the trends in place that anyone can see. It does not take a degree to tell you that when we rely on exports that will decline rather than production that we are able to sell to our own consumers to sustain income for the typical family, we are in a heap of trouble!

Our real incomes are falling, inflation is rising along with unemployment, which means that the housing bubble has a long way down before bottom. Add to that the number of businesses that close, vacancy increases, property taxes collected for state and local government declining drastically (hear about NY City and Wall Street Loses effect on tax revenue)? And before long you get the picture that things are worse than the economist forecast of a fraction of a percentage point!

Commercial real estate has not been talked about much, but the fraudulent appraisals and phony values that back up so much of the mortgages held by both large and small banks will soon cry out in shock and pain. Beware of where you put your money! The REIT industry has not been faced with this question yet, but it soon will be as vacancy rises, rents fall, foreclosures increase and banks have no way to loan enough for buyers to step in to buy the sharply discounted properties... except those that have CASH and lots of it. That is how the super rich made it coming out of the depression of the 1930's. Keep your powder dry, this market will not see a bottom for about 2-3 years or more (compare with the 2000-03 recession) year, IMO.

2008 Aug 12 06:36 PM

[BrianZach:]

Based on the concept of opportunity cost, if anyone had the gift of making accurate economic forecast, they would be running hedge fund instead of being an economist.

2008 Aug 12 11:53 PM