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2017 30

Forecasting, Huh, What is it Good For?

Tim Shea

Special Contributor

Economic forecasting, i.e. surveying the current landscape in the hope of divining out what the future economy has in store. Seems pretty sensible, right? Unfortunately, the most reliable aspect of our modern economic soothsaying is that it’s usually wrong. Sometimes, the inaccuracies are relatively minor, like underselling quarterly GDP growth by half a point. Other times, the lack of adequate foresight is a little more…catastrophic. And embarrassing.

In fairness to our noble profession, accurately predicting the future swings of the economy is no small feat. It requires taking into account the actions of billions of players pushing trillions of dollars a year. Even more maddening is that any number of hard to predict and not strictly economic factors—think 9/11, or Hurricane Katrina, or the OPEC oil embargo—can dramatically and sometimes permanently change the trajectory of the economy in the blink of an eye. It’s hard get a forecast right when you literally have acts of God to contend with. 

Alright, now that we have defended the honor economists, it’s time for the ugly truth: economic forecasting is always flawed. It’s the nature of the beast. What’s more, if you treat high-level economic forecasts as the Gospel on which you base all of your investment or business decisions, you’re setting yourself up for failure. But saying something is flawed is not saying something is useless. At it’s essence, economic forecasting is a tool, and just like any tool, it’s only useful if you know how to use it.

First, there’s the fact that while the economic consensus sometimes gets it wrong, particularly when it comes to downturns,  it is just that: a consensus. Frequently only the majority opinion gets widespread exposure, but there are other views out there. In the lead up to the Great Recession, for instance, quite a few professional economists accurately predicted at least some aspects of the soon-to-unfold chaos. They were an ostracized minority, true. But they do demonstrate how exposure to multiple economic viewpoints can lead to some key insights into the future of the economy.

It is also important to remember that no economist worth the title is making up their forecasts out of whole cloth. They are pouring over hundreds of vital statistics, teasing out trends, and studying detailed research and analysis of past economic events. Sadly, due to the sheer number of variables involved, this intense leg work does not necessarily translate into high-level economic future sight; GDP forecasting will always be a dicey game. But what this plethora of research can do is provide a glimpse into how narrow bands of the economy will perform. Perhaps this is not as comprehensively useful as we’d like, but it does have important implications for things like policy analysis.

Consider, for example, the work of the Congressional Budget Office, whose job boils down to forecasting the economic impact of the Federal government in ten-year swaths. One of the CBO’s more famous pronouncements in recent years was a report stating that Affordable Care Act would cause a significant decline in the number of hours worked by U.S. employees. While the specifics of their findings were misconstrued for political purposes, it is still an example of economic forecasting done right. Based on sound research conducted by respected economists into a naturally occurring economic experiment, the CBO was able to extrapolate important effects of a specific policy on the future U.S. labor market.

It is in these narrow bands that economic forecasting is most effectively utilized; to analyze the future of a policy, or industry, or small geographic area. Perhaps that’s not as sexy as calling the next economic catastrophe, but then again, what is? It is also worth noting that wide-sweeping and small-scale economic forecasts are not distinct entities. They are often two sides of the same coin, a quest to better understand the diverse and complex economy on which we all rely. So yes, take prognostications about the exact date the next recession will hit with a heavy dose of salt. However, that does not mean (as the famous saying goes) that you should throw the Bernake out with the bath water. 

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