Why economists can’t predict the future

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As Stephen Gordon wrote last month in Econowatch, the Bank of Canada has been wrong for at least the past four years. It’s not alone. A study released today by the Organization for Economic Cooperation and Development into its own considerable forecasting errors during the financial crisis offers a detailed glimpse into why economists have such a poor track record predicting where the economy is headed.

The OECD admits its own year-ahead forecasts for the global economy were off by an average of 2.6 percentage points between 2007 and 2009. That might seem a small error, but it actually represents a gargantuan mistake. For instance, in that range an economist could predict the Canadian economy would grow at a rate of 1.5 per cent, when it actually fell by 1.1 per cent: the difference between slow, but positive economic growth, and a recession.

Forecasting got more accurate in the aftermath of the recession, but the organization’s errors still overestimated annual growth by an average 0.3 percentage points between 2010 and 2012.

The OECD is the latest international organization to issue a post-mortem on its forecasting problems throughout the global economic downturn.  The International Monetary Fund issued a rundown of its forecasting errors in 2012. But in its recent report the OECD offers up a few reasons for its poor track record — which typically expected the global economy to improve much faster than it actually did — that can help Canadians understand why our own central bank so often gets it wrong:

Among the findings:

  • Historically forecasters generally ignored the state of the financial sector in their forecasts, since it wasn’t seen as having a significant impact on economic growth. That meant they largely missed both the massive growth in bank credit and the dramatic expansion of financial institutions across international borders that sparked the credit crisis.
  • They assumed that European leaders would quickly move to shore up the eurozone’s most troubled banks—as the U.S. did—and that Europe’s economic crisis would slowly wind down, with government bond yields gradually converging across the region. Instead, Europe experienced almost the opposite phenomenon: political battles over how to shore up the continent’s banking sector and whether or not to bail out broke countries like Greece, sparking the sovereign debt crisis.
  •  They suffered from groupthink. “We all went to the same schools and we’re taught to think about economics in the same way and we’re looking at the same data,” says OECD economist Sebastian Barnes. “So it’s kind of inevitable you’re going to have that.”

The report also suggests that oft-debated austerity policies weren’t responsible for slower-than-expected economic growth outside of Europe. Even within Europe, Greece was the only country where austerity created unpredictable economic shocks. For most other countries, researchers found, the effects of government budget-cutting were easy to estimate in advance and not nearly as harmful as austerity critics suggest. “People often blame the nearest thing to hand, which is to blame fiscal policy” says Barnes. “[The research] really supports the idea that that wasn’t the issue.”

While most forecasters missed the buildup of U.S. housing bubble, the report’s authors say they mostly got it right when it came to predicting what high house prices and a massive buildup of consumer credit would mean for a country’s economy once the financial crisis began. At the same time, they miscalculated how much countries with longstanding trade deficits would suffer in the financial downturn.

As for why economic forecasting errors are more likely to overestimate than underestimate growth, OECD chief economist Nigel Pain says it’s often easier to find positive signals in the economy than spot signs of an impending crisis. Economists have typically missed the biggest shocks to the economy: the oil crisis of the 1970s, the dot-com bubble and the U.S. housing collapse. Also, central banker and political leaders are hardwired to promote themselves as stewards of the economy and therefore gravitate to signs that they’re doing a good job. “Countries are always a bit more welcoming of positive news than bad news,” he says.

Given how badly most economic forecasters performed throughout the financial crisis, economists are moving away from their old forecasting  models. Those typically relied on data from industry and government, much of which is released months after the fact, only to be revised again months later. Instead, Barnes says, central banks are increasingly looking at “nowcasting”—using more real-time data and more informal sources to gauge the health of the economy.

OECD economists now spend more time talking to business and financial leaders to gather anecdotal information about the state of the financial markets. Some central banks have begun to incorporate “big-data” into their forecasts: financial data such as real-time banking and credit card transactions, updated minute-to-minute, in order to spot the early warning signs that the economy is about to take a nose dive.

“One of the problems in forecasting is just knowing where we are today before we start to think about where (we’re headed) in the future,” Barnes says. “So these kinds of things would allow us to monitor the economy more in real-time could really help us a great deal.”

Another word of advice to central bankers? Stop pretending you have all the answers. “One of the lessons of the crisis is that we have to be more humble about what we know,” he says.

The OECD studied the accuracy of its economic forecasts dating back to the 1970s. In general, it was more accurate in predicting economic growth in North America than in Europe. But even in Canada it got it wrong in 39 out of the past 42 years.

The following chart shows the magnitude of the OECD’s forecasting errors for Canada and the U.S. from 1971 to 2012. The forecasts were made in May of that year predicting how fast the economy would grow in the following year. A negative line indicates overestimated growth, while a positive line means the economy performed better than expected. The chart measures the magnitude of forecasting errors in percentage points: so a negative two per cent line means the forecasters underestimated growth by two percentage points (i.e. they predicted the economy would grow at a rate of one per cent, when it in reality it fell by one per cent.)




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Why economists can’t predict the future

  1. Because economists go strictly by numbers, and don’t take human nature into account.

    • Economists actually don’t just go by numbers. The growing field of behavioural economics looks very closely at “human” factors. It has produced all sorts of interesting research. However, it does not help anyone to make economic forecasts.

      • Daniel Kanehman’s Thinking Fast and Slow comes to mind. He’s been quietly doing ground-breaking work in the area of behavioural theory for 40 years now. It wasn’t until Taleb mentioned him in The Black Swan that he got the attention he deserved, which created a market – finally – for a book.

        • Kahneman won the Nobel Prize five years before The Black Swan was published

          • Correct, and still he wrote no book. Until Taleb brought his work to the masses.

        • Errr, thanks for providing a wikipedia link to the subject that I just brought to your attention. However, I’m not sure why you think that is responsive.
          But I am very interested to hear about your global scale thinking and how it allows you to see the future. Please assist us with the bounty of your knowledge: what does the future hold?

          • Okay….if you don’t want to be serious….fine with me.

          • My comments are quite serious. Yours, as always, are ill-informed, flippant, and betray a complete inability to think critically. Like at least 3 people on this comment thread alone, I have called you on your false statements, and your only response is to change the subject. But we’ve all seen this before, so not really a surprise.

          • No, you’re part of the class clown crowd. I’ve told you about the economic future on here dozens of times….if you are incapable of handling it, that’s fine with me.

          • “I’ve told you about the economic future on here dozens of times…” I actually laughed out loud when I read that, so thank you for the levity.

          • Yup, you’re ‘amusing yourself to death.’

            Well, not my problem.

          • I’m trying to think of a single prediction Em has made since 2008 that has come true. Nothing comes to mind.

          • She has previously predicted robots doing – everything!

          • My how nicely and how easily you fitted right in with the Cons

          • You’ve alienated everyone across the political spectrum. Your toxic personality and your inability to abide by basic social norms of decency and manners have an equally repellent effect on left, right and centre. You’re an equal opportunity offender.

          • Nice try – read my feed. I’ve always been anti-reform con – you on the other hand have admitted to being a Reform riding prez. That
            is what I call fitting right in with Cons.

          • You fit right in with the class clowns Jan….the Con guys barracking while their lives go down the tube.

            You belong in the dungeon as well. Water seeks its own level, after all.

          • This is the real world – not a cyber fantasy – there is no dungeon.
            LOL

          • Actually the human mind is the best prison ever devised.

            You’re trapped in yours…..and the cat has your computer apparently.

            No matter anymore. Adios.

          • Oh please, your computer chair seems to be holding you hostage. Call 911.

          • I suspect she/he/it may be a spambot.

        • that guy in the picture up top thinks he can predict the future too. delusions might be comforting, but they don’t improve your forecasting ability.

          • Same goes for you.

          • and i can admit as much. my delusions feel good, but make shitty forecasts. you, on the other hand, brag to us that you’re so gifted and so special that you can harness your global energy or whatever, and predict the future. you’ve solved the riddle a million economists couldnt’s solve. i am in awe.

          • No, you are in bed by the sound of it.

          • how about a prediction about the future, just one on any topic.

          • Sure…..no stores, no factories, no cash, no TV channels or networks…..and that’s only 20 minutes into the future.

            You want further into the future? No countries, a network of cities worldwide….we might even get into space for the first time. LOL

            And robots doing everything from flipping burgers, building houses and cleaning them to building starships.

          • if you believe it, it will happen. To you!
            Not society

          • Already happening I’m afraid. All over the world.

          • I’m pretty sure that’s a picture of Ron Waller. Looks a little older than I would have guessed.

      • First of all, the field of Behavioral Economics is largely based on research in the area of sociology, which is a field that economists have historically thumbed their noses at. Second, Behavioral Economics contradicts some of the assumptions at the heart of free market theory, namely, that market participants behave rationally. What I don’t see are economists using these “new” findings to refine their theories. It’s no wonder that we can’t accurately predict the future when using economic models that don’t accurately account for human behavior.

    • Most economists have a very politicized and flawed view of economics. Take Keynes, an unemployed economist ooking for a job, realized getting a job was to tell politicians to spend-debt-spend and spend….music to a politicians ears.

      But it ignore the reality of you can’t debt-spend your way out of a debt problem, but you can make it worse.

      But when Bernanke got in, he lowered interest rates and created money to fund governemtn debt, they upset the value of currency and caused the depression.

  2. Dan Gardner of the Ottawa Citizen recently published a book on this topic called Future Babble. He demonstrated quite convincingly that economists have absolutely no ability to predict what the economy will do in the future. This isn’t because economists are stupid – many of them are extraordinarily bright. But there are simply too many variables that go into the economy, and it is for all intents and purposes impossible to predict what will happen. Indeed, this has been known for quite a long time: there are many decades worth of research showing that economic forecasts – no matter who makes them – are not worth the paper they are printed on. Witness Maclean’s’ endless predictions of a real estate crash.

    • Exactly. Physicists have always known this. You can accurately predict the gravitational influence that two planetary bodies have on one another. But if you add just one more planetary body, so that three individual masses are all exerting gravitational pull on each other, their behaviour becomes entirely impossible to predict. Yet economists (and let’s be fair, other professions as well) plug scores of variables into their regression models believing that more data and more finely tuned parameters will lead to better forecasts.

        • uh, did you read the article? they admit they haven’t solved the 3 body problem, they only discovered mathematical solutions for calculating possible paths, given certain initial conditions were met. it supports what RR says.

          • Someone expressed an interest in a topic….so I thot he might like to read it.

            Is that okay with you, or do I need a note?

          • A note, no.
            A clue may be nice.

          • Well you’re en route for the dungeon anyway, so I won’t waste time explaining courtesy to you….since obviously your mother didn’t.

          • She died at an early age, o heartless one.
            Thanks.

          • Your dad has no manners either?

          • It was an interesting article. I hadn’t given the 3 body problem a thought in years, and didn’t realize physicists were still trying to get a handle on it. Thx.

    • the same goes for the global climate disruption crowd. flawed models, political contamination and cherry picked data

      • climate is different in that it is not affected by human psychology. however, there are too many variables to make accurate global climate models.

      • But that doesn’t mean there’s a counter factual out there that “proves” Climate change isn’t happening or isn’t man made. What the bulk of climate scientists have going for the is weight of evidence. I’m not sure the denier crowd have much of anything…certainly very little hard core peer reviewed research. Mostly they add up to a chorus of: it’s too hard to predict. Which while not unreasonable is no reason to quite digging or take sensible precautions.

        • True enough. I tend to look at the physical evidence, not the computer model predictions (which I think are bunk). The rapidly melting glaciers as seen by satellite photos since 1980 or so scare the living crap out of me.

          • Agreed, the little things matter, even if you can’t base your entire policy on anecdotal or oral evidence.
            I live North of sixty and it’s commonly held that the magpies we now have [up from AB i presume] were nowhere to be seen 30 years ago. Then there’s all the evidence from the Inuit elders further North…all the new insects turning up they have no words for. We’re leaving a scary, perhaps unpredictable, world to our kids.Regardless of your political views on AGW we ought to be preparing for the worse and hoping for the best.

          • I believe magpies, along with ravens, are exploding in numbers since they are no longer being poisoned. I read a report about ravens in particular a few years back. They feed on carion, and apparently had almost died out due to the common practice of leaving poisoned carcasses out for wolves and coyotes, a practice that only ended in the 60s and 70s (believe it or not). Magpies also feed on carion, so they could be rebounding as well. As for the bugs, I’ve got no explanation for that one.

            I will say that I don’t believe mountain pine beetles are caused by climate change. They’ve always been present. They’re called a “native invasive species” because they’ve always been in the mountains of NA, just not in the numbers they have now. I believe our policy of fighting fires instead of letting them burn has caused some serious long term damage to the mountain ecosystem, and this is a far more likely explanation.

            Those 19 firefighters who died in Arizona last year might be symptomatic of the same thing. Fires used to be a normal thing in that area. Now they are fought (they have to be) but the tinder and debris builds up over decades, until you have a big one. Regular fires every few years used to prevent the massive ones from happening.

          • Agree with you about fires. It fits into the newish thinking about whole eco-systems, rather than just tidy little parks.
            I’m not sure if current informed thinking is blaming the MPB disaster soley on CC…but it is exacerbating it.
            As for the magpies, most common opinion puts it down to winters not being as long or hard. Certainly not true this year.
            Thank goodness that awful poisoning programme has mostly ended now. Lots of collateral damage there i bet?

          • I visited a wolf rescue haven just outside Golden BC in September 2012. The people running it say that wolves are still being poisoned. They were pretty hard core conservationists with an agenda, so I took it with a grain of salt, but they seemed pretty convinced that poisoning was still going on. Whether they were referring to officially sanctioned poisoning or illegal poisoning, I’m not sure. I would hope the government does not carry out such programs itself anymore. There are better ways to cull if that’s what they decide to do.

          • Wow. What ignoramuses voted down a call for preparation? Even Con critics aren’t opposed.
            [ one of them was bound to be that first rate fool Omen]

          • a better word for them is ignoranus

        • I agree with you to some extent, although I would suggest that a good deal of the peer review that supports the theory is suspect and often unvetted. I also agree that there is no reason to stop digging, the consensus crowd seem to have a problem with that however.

          • You may suggest but i’d need actual evidence before i accepted it.
            As for digging, aren’t you being a bit one sided? I don’t hear a lot of the skeptics saying keep digging boys. Mostly i hear them yelling…It’s all BS…and come and look at my nice shiny nutty new theory about the sun over here. OTOH i do hear the consensus crowd attempting to rebut many of these other “theories.”

          • here’s a start for you.
            http://wattsupwiththat.com/?s=peer+review+issues

            Yes there are those that yell, on both sides, but the AGW crowd doesn’t exactly have the best record in terms of accurate predictions, given that, “nutty” theories about the sun may be worth considering

          • Oh god, is that weather man Watts? Please desist.

          • knew that was coming from the likes of you, attack the man don’t worry about his arguments its much easier that way isn’t it.

          • My advise to you is to get a better source. Even “someone like me”, who’s only observing from the sidelines knows Watt is widely seen as a joke amongst real scientists.
            I don’t normally subscribe to attacking the man rather than the idea, but there are better sources out there surely?

          • The saner skeptics tend to avoid these discussions for the most part these days as you’ll be jumped on by dozens of climate-change evangelists providing you with links from one-sided websites, their personal weather experiences, and screaming consensus. Breaking down said ‘consensus’

            1) the earth is getting warmer: there’s data and while not conclusive (the further you go back in history the less reliable the data sources are and you need hundreds of years to properly demonstrate a trend), one has to say this is probably the case.

            2) the primary cause for this is manmade ghg emissions: and here we already enter into something that has to be ‘proved’ by the very shaky models. The ‘greenhouse’ properties of CO2 can be tested but the magnitude of the effect on a system as complex as the earth has to be found through modelling. I can’t personally make a critique of any given model as i’m not an expert on the subject but then neither are most of the people yelling consensus. What i can say is these models are incredibly complicated and apart from waiting 50 years to see if they can accurately predict the future, there’s no real way to verify them.

            3) without curbing said emissions, there will be catastrophic effects: this relies on the aforementioned models to attempt to make a prediction 25-50 years out of what would be the effect on climate for a given emissions profile combined with ‘best guesses’ of what the earth would look like under a given amount of warming. aka this part is even shakier than the models themselves.

            Given the uncertainty, a cautious approach would indeed be to do ‘something’ to try and reduce emissions rather than find out if the models are correct. Some of these actions even make sense for reasons other than the CO2 bogeyman (i.e. more energy-efficient housing is an all around win). The issue becomes that the most vocal of proponents for change tend to call for drastic action rather than targeting the low hanging fruit. And for example, when you start calling for a halt to oil sands development, you make enemies of people who would normally be neutral or cautiously accepting of the direction you want to go.

          • Fair enough. But who outside if a very marginal fringe want the oilsansds shut right down? Even most mainstream dippers are at worst calling for a slowdown. Last I checked Lougheed wasn’t a dipper. People always point to this end of the extreme and rarely to the other end; the business class folks who want to steam ahead at full speed. This is an equally irresponsible position; and one that comes up in debate far less frequently than the bring back the horse and cart crowd. I submit this group is considerably larger than is commonly held to be the case. A fair number of them belong to this Harper govt.

  3. Too many variables. It is not possible to make accurate economic predictions, no matter how complex your model is, no matter how you try to adjust for market psychology.

    • Accurate predictions are only possible if your perception of the environment is accurate to the reality.

      The real problems are politicians and government economists are not looking at the problem correctly. I say 2008 coming. As I knew creating money for negative value interest rates (rates below real inflaion+taxes) was a sure sign of economic failure to come. Several older 30, 40, 50 economic books talk of this. But liberal economists still have a hard time admitting Keynes just said what politicians wanted ot hear to get a job.

      Jobs are not created by government or GDP, jobs are exclusively created from the affordable exchange of goods and services. Nothing more complex than that for jobs. So taxing people anad giving devalued money only makes job situations worse. But the opposite is true, tax people less and have a governemtn balanced budget for money value stability, and their will be more jobs.

      But governemtn fails to admit, it can’t solve the economic problems as its perception is flawed. You can’t debt-fraud spend out of a debt-fraud problem. No nation has succeeded in prospering from this fraud. Because how does a statism (big government) admit that its excessive consuption and waste is the problem?

      Government has many of the same denial issues as do people.

      • Thank you Ayn Rand. No talk of a return to the gold standard? I’m disappointed.

        • …..or the ‘illegal’ federal reserve. LOL

      • Accurate predictions are not possible at all. Well, they are possible in the sense that one can make a lucky guess, but humans will never be able to accurately and consistently predict the future state of the economy.

  4. OECD and governments could see it coming as they use a flawed economic model that makes outright bad assumptions as they don’t want to admit governments printing money for debt are the cause of the entire depression. They also fail to see why having interest rates below inflation+taxes for a negative value economomy is ultimately a bad thing.

    Lets show the 10 year chart on USD value that shows currency value from money print and other events, as it shows clearly the new banking fraud started in 2006 and caused the mortgage and unemployment crisis:

    http://www.xe.com/currencycharts/?from=USD&to=CNY&view=10Y

    Deny it you may but doesn’t change the fat that when governments started creating money to keep fraud low debt rates, they expanded and diluted the money supply for inflation. People with less value money from taxes and devaluation, spent less on other peoples jobs and it snowballed.

    This depression would have never happened if:

    1) Interest rate were inflation+taxes or slightly higher to deter debt.
    2) US Fed/BoC/Eurobanks and others didn’t create so much money for fraud lending. Fiat lending of no value creted money caused it. Be like you or I lending ourselves photocopied money, only legal as governemtn does it. Practices should be banned.
    3) Balanced government budgets need to be there at all costs, stop the political BS, putting debt on our kids and grad kids, is immoral and unethical. And without fair equitable currency, your not going to have a good economy. You cannot have the pie and eat it too.
    4) Bailouts don’t work. Tax us more to bailout someone, we ultimately will spend less on someone else’s job. No avoiding reality, government cannot create wealth out of thin air. If they could we would all be rich and starving as who will produce and deliver food?

    The depression is really about moral, ethical corruption and statism greed. Governments can’t fix the economic issues as they really cause the issues with the monetary and debt fraud.

    And it isn’t over as our debt-greedy governments refuse to admit real economics basics. Preferring the liberal feel good and propaganda…. but reality always wins in the end.

  5. It seems that the past too is open to interpretation.

  6. Not all forecasters missed the housing bubble. As when Bernanke got in he started creating no value money for governemtn debt and to force interest rates to fraud low levels.

    If we had a market balance, cost of debt would have risen to cool off the rise of debt. But what low interest rates did was pump up the bubble faster and started higher inflation rates. In 1914 and 1971 money was no longer assocated with value, so the more you fraud-print, the less value money become, we call it inflation.

    Before 1914 inflation, hyper taxation didn’t exist, jobs everywhere too. But in 2006, our governments started counterfieting its own currencies to buy debt no one else will. No way am I lending others money in 6% real inflation for 1% return, that is negative value investing. So it caused the credit crunch and then the crash as governments are in denial, they are the problem and not the solution.

    In a nutshell, our governments really refused to live inside their means and fraud fiat currency since 2006. And this downturn in US/Canda/Europe/Japan is not going to stop until the governments take a real rational look at how they are causing the problems.

    Here is a hint, you can’t keep creating fiat currency dollars faster than sheets of toilet paper for bloated governments and cheap debt fraud forever, as eventually the currency becomes worthless…and remember….jobs are created by affordable exchange of goods and services…… Worthless fiat money removes the affordability and devalues a economy.

  7. pj o’rourke – economics is an entire scientific discipline of not knowing what you’re talking about.

    • It’s not a scientific discipline. Scientific disciplines refine their theories when they are contradicted by behavior in the real world.

  8. IOWs economic prediction is pretty akin to predicting the weather…the further out you get, the more data you plug in the more iffy it becomes. It’s generally easier to analyse yesterday’s weather than to predict tomorrow’s with any certainty.

  9. Economists are people they make mistakes but they have to look into the greater picture not just at the numbers.

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