Why Economic Forecasts So Often Miss the Mark
Here’s “a good explanation for an error that large”
by Bob Stokes
Updated: October 12, 2021
Economists periodically issue statements about what they expect is ahead for the economy.
So often though, these forecasts miss the mark.
A March 2019 Bloomberg article put it this way:
[A] review of the past suggests that those who are paid to call turning points in economic growth have a dismal record.
Well, to start off with, Fed economist Jeremy B. Rudd just published a paper which challenges some of his profession's core tenets.
The New York Times mentioned the paper and said (Oct. 1):
The Rudd paper... reflects a broader rethinking of core ideas about how the economy works and how policymakers, especially at central banks, try to manage things...
The period from the mid-1980s to 2007... seems to be a high-water mark for economists' overconfidence.
Consider that on March 1, 2007, an article reported that "Federal Reserve Chairman Ben Bernanke assured Congress... that he was sticking by his optimistic economic outlook." A few months later, a group of economists were polled and unanimously agreed that economic expansion was ahead.
Instead, 2007 kicked off the worst economic slump since the Great Depression.
The reason why economists often get it wrong is that they generally extrapolate a current trend into tomorrow. When Bernanke and the economists who were polled predicted further economic expansion, the financial trend was still upward.
More than that, a consensus that the old trend will continue develops just when a dramatic change is near.
Let's review another example of when a consensus crystallized among economists.
This chart and commentary are from Robert Prechter's 2017 book, The Socionomic Theory of Finance:
You can see that economists' conviction in June 1984 that interest rates would continue rising (and bond prices would continue falling) derived from linear extrapolation of a trend that had persisted since the 1940s. That trend had already ended in 1981. But economists' passion relating to the old trend was so strong that when rates headed back up in 1984 the only direction that felt right to them was up.
Here's the next chart:
Just look at the dramatic plunge in interest rates over precisely the twelve-month period that they predicted they would rise and the downtrend's relentless continuation ever since. Herding is a good explanation--and a respectful one--for an error that large and conviction that perfectly mistimed.
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Why News is Irrelevant to the Stock Market
The conventional view assumes that good news sends stock prices higher while bad news drives stock prices lower.
Yet, Robert Prechter’s landmark book, The Socionomic Theory of Finance, shows that this conventional assumption is incorrect, even in the case of extremely dramatic news.
This is from the book:
Suppose the devil were to offer you historic news a day in advance, no strings attached. “What’s more,” he says, “you can hold a position in the stock market for as little as a single trading day after the event or as long as you like.” It sounds foolproof, so you accept.
His first offer: “The president will be assassinated tomorrow.” You can’t believe it. You are the only person in the world who knows it’s going to happen. …
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