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Why Mainstream Economic Forecasts Are So Often Wrong

General Ideas

Every end of the year, by the end of the year, we receive numerous estimates of global GDP growth and inflation for the following year. Historically, almost in all cases, expectations of inflation and growth are too optimistic in December for the following year.

If we look at the track record of central banks, it is particularly poor in predicting inflation, while large supranational entities tend to err on the side of optimism in GDP estimates. The international Monetary Fund or the Organisation for Economic Co-operation and Development, for example, have been particularly poor at estimating recessions, but mostly accurate at making long-term trend estimates. Contrary to popular belief, it seems that most forecasts are better at identifying long-term economic dynamics than short-term ones.

Forecasting is a dirty job, but somebody has to do it. Economic forecasting is exceedingly difficult because there are numerous factors that can drastically change the course of a global economy that is increasingly complex and subject to important uncertainties. However, macroeconomic forecasting is also essential to provide a frame of reference for investors and policymakers. It should not be considered the revealed truth nor entirely dismissed, just an important framework that allows us to at least identify the major points of discrepancy as well as the areas to look at for positive or negative surprises as the year unravels. Yes, macroeconomic forecasting is essential.

The first lesson is that independent forecasts are almost every year more accurate than those of supranational bodies and central banks. There is a logic behind it. Independent forecasters do not feel the political pressure to use a benign view of government policies in their estimates. This is one of the main reasons why investors increasingly use their own economic forecasting teams alongside truly independent firms. While it is always worth paying attention to investment banks and international bodies’ forecasts, most investors have learned to understand that the estimates of these large entities are often blurred by political correctness and a tendency to be overly diplomatic. Notice how even in countries where governments have destroyed the economy with wrong policies, one-year-ahead forecasts tend to be diplomatically optimistic.

The second lesson, particularly after years of financial repression, is that most forecasts tend to assume an optimistic and extraordinary multiplier effect from government spending and central bank stimulus plans. In most cases, when we look at the estimates of large central banks and international entities, the biggest mistakes in forecasting come from expecting a surprisingly large positive impact on consumption, growth, employment, and investment from demand-side policies. In my experience, the two largest divergences between forecast and reality tend to appear in capital expenditure (capex) and inflation. This is not a coincidence. When the forecaster places too much weight on demand-side policies while ignoring the accumulated debt, overcapacity, and poor track record of most of these measures, the mistakes in capex and inflation forecasts are almost inevitably going to be enormous and much larger than the mistakes on output and employment. Likewise, the tendency of large forecasting entities of ignoring or dismissing supply-side policies leads to forecast errors on the side of caution. This was particularly evident in the recovery of some eurozone countries in 2014 and in the estimates for jobs and growth of 2018–19 in the United States. One of the clearest examples is the almost annual slump in growth in the eurozone relative to early estimates.

The third lesson is that forecasts tend to be significantly more accurate when negative news is already consensus. Even when considering risks that may erode significantly the estimates for the next year, large entities tend to consider a lower probability of occurrence of those events in order to maintain a “positive” outlook. There are still too many politicians and economists who believe that the economy is a matter of sentiment and animal spirits and that, as such, one should maintain a healthily optimistic outlook to support the economy. This has obviously been debunked by reality. Being too optimistic has impacted the credibility of very valuable forecasts while doing nothing to lead economic agents to see a brighter prospect in a recession.

In the past nine years we have seen important improvements in economic forecasting. Some investment banks have stepped out of their historical role of painting rosy outlooks where next year is always a “this time is different” story, and we have seen a more realistic approach. Unfortunately, there is still an eyebrow-raising tendency to end global outlook reports with the same recommendations every year: carry trade your way into the next twelve months.

International bodies have also improved. We have are seeing a much more realistic approach to forecasting than ten years ago, but inflation and GDP estimates still err on the side of figures that governments will be happy with. However, the intense and rising pressure from governments that these bodies are receiving is actually a sign that forecasting is becoming more independent.

The final lesson for us as investors is simple: take with a pinch of salt those estimates that place too much positive impact on government and central bank stimuli. Remember that things that have never happened and multipliers that have never occurred are not going to happen, even less so with all-time-high levels of debt and widespread overcapacity.

Reading only mainstream macroeconomic reports, even if coming from different entities, can lead to a massive confirmation bias, and I learned many years ago that we may get dozens of different sources that ultimately just say the same thing: government spending is always good and central banks always get it right.

We must also remember that mainstream bodies are almost entirely populated by Keynesian economists, and there is a tendency to adopt the messages of pressure groups in the economic debate, as we are witnessing with things like the Great Reset, the whitewashing of MMT (modern monetary theory) and the adoption of concepts like inequality, stakeholder investment, and social spending in ways that are uncomfortably close to the political agendas of some interventionist parties. Mainstream bodies should have understood by now that adopting political mantras does not combat wrong economically radical agendas, it only undermines the entity’s credibility.

Independent research and forecasts have become increasingly important precisely because of the lack of pressure from governments or central banks to produce a predesigned estimate. And this rise of the independents has been absolutely critical to spur international bodies and investment banks to step up their game. That is why it is so important to use different sources of research.

The best way to use forecasts is to do what many of us learned to do, for example, with brokers’ equity and fixed-income research, forget the first page and read the data, the details and the deep content. The headlines and recommendations of brokers and international entities should be the last thing to read in outlook reports.

Forecasting is essential. Independence is key. Independent forecasting will be even more important in 2021 than it was in 2020.

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5 Comments on "Why Mainstream Economic Forecasts Are So Often Wrong"

  1. makati1 on Fri, 15th Jan 2021 5:03 pm 

    “Why Mainstream Economic Guesses Are So Often Wrong”

    Trying to guess what 7,800,000,000+ people will do tomorrow is hilarious! And those seven plus billion decisions will dictate the future,not some numbers from the past. But, its fun to read and laugh at.

  2. makati1 on Fri, 15th Jan 2021 5:12 pm 

    “A young person sees the world as a still picture, immutable. An old person has had his nose rubbed in changes and more changes and still more changes so many times that he knows it is a moving picture, forever changing. He may not like it – probably doesn’t; I don’t – but he knows it’s so, and knowing it is the first step in coping with it.”

    ‘Lazarus’ in R.A.Heinlein’s “Time Enough for Love” – 1973.

  3. Duncan Idaho on Fri, 15th Jan 2021 5:44 pm 

    Right Wing Goons turning on the Fat Boy:

    https://www.huffpost.com/entry/trump-supporters-betrayed_n_60016777c5b62c0057bc11ab

  4. FamousDrScanlon on Fri, 15th Jan 2021 7:02 pm 

    The new astrology

    By fetishising mathematical models, economists turned economics into a highly paid pseudoscience

    “Unlike engineers and chemists, economists cannot point to concrete objects – cell phones, plastic – to justify the high valuation of their discipline. Nor, in the case of financial economics and macroeconomics, can they point to the predictive power of their theories. Hedge funds employ cutting-edge economists who command princely fees, but routinely underperform index funds. Eight years ago, Warren Buffet made a 10-year, $1 million bet that a portfolio of hedge funds would lose to the S&P 500, and it looks like he’s going to collect. In 1998, a fund that boasted two Nobel Laureates as advisors collapsed, nearly causing a global financial crisis.

    The failure of the field to predict the 2008 crisis has also been well-documented. In 2003, for example, only five years before the Great Recession, the Nobel Laureate Robert E Lucas Jr told the American Economic Association that ‘macroeconomics […] has succeeded: its central problem of depression prevention has been solved’. Short-term predictions fair little better – in April 2014, for instance, a survey of 67 economists yielded 100 per cent consensus: interest rates would rise over the next six months. Instead, they fell. A lot.”

    https://aeon.co/essays/how-economists-rode-maths-to-become-our-era-s-astrologers

    Economics is capitalisims secular priesthood & their main function is to legitimize the status quo & the overlords no matter what. Same as every priesthood in history.

  5. Theedrich on Fri, 15th Jan 2021 11:56 pm 

    Latest Leftist trick: ENTRAPMENT of Trumpists. Pretend to be super-Rightist and e-mail all pro-Trump people to surround their state capitols with guns.  Then infiltrate Conservatives’ demonstrations and incite a riot, with plants torching cop cars and buildings, so that the MSM will blame it on White traditionalists.  The new MSM dogma is now:  there are good violence and bad violence.  (Guess which kind is Leftist.)  Outrage must be selective, favoring the Commies.  Kill White conservatives, imprison their children.  Similarly, Universities have gone full-blown Marxist.  Orwell only.

    Tech Bolsheviks are shutting down anything unLeftist.  They are doxing the employees of companies, like Parler or Gab, which present a non-Bolshevik point of view.  “Free” speech means only Stalinists get to speak.  And only they can hold power.  Away with the capitalist Constitution!  The masses must be hypnotized and terrorized into submission.  Thought crimes must be punished.

    Terror always works.

    As in the case of Russia in 1917 and China post-WW II, we can expect that “dialectical materialism” will bring us a future of horror behind the mask of a workers’ paradise.

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