Forecasting the storm: are economic forecasts a waste of money?

Following the Autumn Statement last Tuesday big headlines came from a few little numbers – the UK’s revised growth forecasts from the Office of Budget Responsibility (OBR). All were reduced, with the 2011 forecast down from 1.7% to 0.9%, 2012 from 2.5% to 0.7% and growth for the following three years predicted at 2.1%, 2.7% and 3%. The news is bleak but it does suggest that we are at least going to avoid another recession. However, Osborne admitted that “the debt storm in Europe” could take the economy into a double dip. The Organisation for Economic Co-operation and Development (OECD) claims it is probable. In acknowledging this, the forecast figures themselves are called into doubt, the question remains: are the OBR’s figures being taken seriously.

Historically, there have been quite a few examples of terrible economic forecasting. In September 1929 the Secretary of the Treasury was quoted saying, “There is no cause to worry, the high tide of prosperity will continue.” More recently, in 2005 Chairman of the Federal Reserve Ben Bernanke reassured American citizens by saying, “There is no housing bubble to go bust.” Although these examples were spectacularly wrong, as far as poor predictions go, they are not exceptional. In a comparison of forecasts made by a panel of leading economists forecasting for the Wall Street Journal, Mark Greer found an accuracy level of 49% – not much different from the expected value of a random forecast generating mechanism. In other words, we might as well have my little sister form predictions on inflation and growth; she may even do a better job than Bernanke.

The reality is that we just don’t know enough about economic drivers. The predictions we make about the potential effect of policies work with all else taken as constant. We know that lowering interest rates means we have more money in the economy and that this stimulates lending. With quantitative easing, the Bank of England hoped for this effect – but all else was not constant. The recession has led to a drop in confidence and even with extra money in the system, growth in lending to UK businesses has continued to decrease since 2009. In forecasting, we know that these opposing effects exist but it is difficult to predict their magnitude. Add to that the fact that through globalisation we are constantly being affected by the international economy, the challenge becomes clear.

The latest Bank of England inflation report does not factor the European crisis into its forecasts of inflation or growth; they deem it impossible to predict. At a time like this, it is easy to see that this is going to pose problems in the accuracy of the figures. Is the answer to learn more about our global economy and improve understanding? Economics is a fairly young discipline compared to traditional subjects like philosophy and theology and there’s a lot more to be discovered. However, the nature of economics dictates that it can never be an exact science because it relies so heavily on human behaviour and we’re just not that rational.

When you consider all of this, forecasting itself can be called into question. Imagine a weatherman who got it right only 49% of the time. Although sometimes this doesn’t seem far from the truth, if it were really to be the case we might choose not to bother listening. Except in this case it’s a little more serious – we could face an unexpected recession.

Despite all this, paying economists to conduct economic forecasts is by no means a waste of public money.

Even when it’s really wrong, forecasting can be credible. If it uses everything we know to create an unbiased estimate of what’s going to happen, it can be used to hold politicians to account. Without credible economic forecasting, Osborne could have told everyone in his autumn statement that we were about to wake up from our economic nightmare because austerity had fixed everything. He could have kept saying that until next election – we wouldn’t know better.

Economic forecasting cannot actually forecast the economy. However, it does tell the public everything economics predict of the future given what we know at present. By doing so it makes sure that people are informed on the effects of the Government’s choice of economic policy – and all this comes from just a few little numbers.