Why economic forecasters underperform fortune tellers

In Economy, Financial competency on 20/10/2013 at 5:23 am

(Taz all the more reason to stick to stocks that make can make sustainable (we hope) good payouts. Check Temasek’s Fab 5 out: they have consistently made gd payments but the prices reflects this i.e. better yields available elsewhere but at greater risk.)

[A]n advance estimate showing the city-state’s economy shrank 1.0 percent on quarter in the July-September period, better than expectations for a 3.6 percent contraction, but a significant deceleration from 16.9 percent growth in the previous three months.

Opps wrong again. And govt isn’t that gd either at forecasting. A few months ago: The Republic’s economy is expected to do better this year than previously expected, with the growth forecast raised to between 2.5 and 3.5 per cent, Prime Minister Lee Hsien Loong said yesterday.

The previous official forecast was between 1 and 3 per cent. [Today]

In both cases, in percentage terms, the changes are significant: a fortune teller would lose his credibility with such forecasts. All finance ministers, their advisers, economists, central bankers and analysts always get their forecasts wrong: nothing uniquely S’porean.

In addition to the general reasons I gave here, here are two more reasons for them being sotong in the post 2008 environment.:-

— The experts are lost because the conventional model of how the financial system interacts with the real economy has evolved too little since the huge and largely unexpected financial crisis. Now as then, there is too much debt in the world for either monetary or fiscal policy to have the effect that the textbooks say.

The stimulative efforts of governments and central banks help the highly leveraged financial system stay afloat, but only a small portion of the funds actually reach the real economy. In such an unconventional financial world, the conventional wisdom is likely to stay wrong. Expect more of the unexpected.

— Economics is an inexact science, with exceptions to almost every pattern of behaviour that economists take for granted. For example, economists predict that higher prices for a good will reduce demand for it. But students of economics will no doubt remember an early encounter with “Giffen goods”, which violate the usual pattern. When tortillas become more expensive, a poor Mexican worker may eat more of them, because she now has to cut back on more expensive food like meat.

Such “violations” occur elsewhere as well. Customers often value a good more when its price goes up. One reason may be its signalling value. An expensive handcrafted mechanical watch may tell time no more accurately than a cheap quartz model; but, because few people can afford one, buying it signals that the owner is rich. Similarly, investors flock to stocks that have appreciated, because they have “momentum”.

The point is that economic behavior is complex and can vary among individuals, over time, between goods, and across cultures. Physicists do not need to know the behavior of every molecule to predict how a gas will behave under pressure. Economists cannot be so sanguine. Under some conditions, individual behavioral aberrations cancel one another out, making crowds more predictable than individuals. But, under other conditions, individuals influence one another in such a way that the crowd becomes a herd, led by a few.

Unfortunately, many of these methods [to get clear-cut evidence of causality. If high national debt is associated with slow economic growth, is it because excessive debt impedes growth, or because slow growth causes countries to accumulate more debt? cannot be applied to the most important questions facing economic policymakers.] So the evidence does not really tell us whether a heavily indebted country should pay down its debt or borrow and invest more.Moreover, what seem like obvious, commonsense policy solutions all too often have unintended consequences, because a policy’s targets are not passive objects, as in physics, but active agents who react in unpredictable ways. For example, price controls, rather than lowering prices, often cause scarcity and the emergence of a black market in which controlled commodities cost significantly more.


  1. Like I said, no worries man. Stay invested in stuff with large economic moats and reap the Golden Age. Those who worry about 1%, 3% moves will forever be part of the unwashed masses – the hunted instead of the hunters.

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