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Posts Tagged ‘economic forecasts’

Economic forecasts: are they of any value?

Economic forecasting came in for much criticism at the time of the financial crisis and credit crunch. Few economists had predicted the crisis and its consequences. Even Queen Elizabeth II, on a visit to the London School of Economics in November 2008, asked why economists had got it so wrong. Similar criticisms have emerged since the Brexit vote, with economic forecasters being accused of being excessively pessimistic about the outcome.

The accuracy of economic forecasts was one of the topics discussed by Andy Haldane, Chief Economist at the Bank of England. Speaking at the Institute for Government in London, he compared economic forecasting to weather forecasting (see section from 15’20″ in the webcast):

“Remember that? Michael Fish getting up: ‘There’s no hurricane coming but it will be very windy in Spain.’ Very similar to the sort of reports central banks – naming no names – issued pre-crisis, ‘There is no hurricane coming but it might be very windy in the sub-prime sector.” (18’40″)

The problem with the standard economic models which were used for forecasting is that they were essentially equilibrium models which work reasonably well in ‘normal’ times. But when there is a large shock to the economic system, they work much less well. First, the shocks themselves are hard to predict. For example, the sub-prime crisis in 2007/8 was not foreseen by most economists.

Then there is the effect of the shocks. Large shocks are much harder to model as they can trigger strong reactions by consumers and firms, and governments too. These reactions are often hugely affected by sentiment. Bouts of pessimism or even panic can grip markets, as happened in late 2008 with the collapse of Lehman Brothers. Markets can tumble way beyond what would be expected by a calm adjustment to a shock.

It can work the other way too. Economists generally predicted that the Brexit vote would lead to a fall in GDP. However, despite a large depreciation of sterling, consumer sentiment held up better than was expected and the economy kept growing.

But is it fair to compare economic forecasting with weather forecasting? Weather forecasting is concerned with natural phenomena and only seeks to forecast with any accuracy a few days ahead. Economic forecasting, if used correctly, highlights the drivers of economic change, such as government policy or the Brexit vote, and their likely consequences, other things being equal. Given that economies are constantly being affected by economic shocks, including government or central bank actions, it is impossible to forecast the state of the macroeconomy with any accuracy.

This does not mean that forecasting is useless, as it can highlight the likely effects of policies and take into account the latest surveys of, say, consumer and business confidence. It can also give the most likely central forecast of the economy and the likely probabilities of variance from this central forecast. This is why many forecasts use ‘fan charts’: see, for example, Bank of England forecasts.

What economic forecasts cannot do is to predict the precise state of the economy in the future. However, they can be refined to take into account more realistic modelling, including the modelling of human behaviour, and more accurate data, including survey data. But, however refined they become, they can only ever give likely values for various economic variables or likely effects of policy measures.

Webcast
Andy Haldane in Conversation Institute for Government (5/1/17)

Articles
‘Michael Fish’ Comments From Andy Haldane Pounced Upon By Brexit Supporters Huffington Post, Chris York (6/1/17)
Crash was economists’ ‘Michael Fish’ moment, says Andy Haldane BBC News (6/1/17)
The Bank’s ‘Michael Fish’ moment BBC News, Kamal Ahmed (6/1/17)
Bank of England’s Haldane admits crisis in economic forecasting Financial Times, Chris Giles (6/1/17)
Chief economist of Bank of England admits errors in Brexit forecasting BBC News, Phillip Inman (5/1/17)
Economists have completely failed us. They’re no better than Mystic Meg The Guardian, Simon Jenkins (6/1/17)
Five things economists can do to regain trust The Guardian, Katie Allen and Phillip Inman (6/1/17)
Andy Haldane: Bank of England has not changed view on negative impact of Brexit Independent, Ben Chu (5/1/17)
Big data could help economists avoid any more embarrassing Michael Fish moments Independent, Hamish McRae (7/1/17)

Questions

  1. In what ways does economic forecasting differ from weather forecasting?
  2. How might economic forecasting be improved?
  3. To what extent were the warnings of the Bank of England made before the Brexit vote justified? Did such warnings take into account actions that the Bank of England was likely to take?
  4. How is the UK economy likely to perform over the coming months? What assumptions are you making here?
  5. Brexit hasn’t happened yet. Why is it extremely difficult to forecast today what the effects of actually leaving the EU will be on the UK economy once it has happened?
  6. If economic forecasting is difficult and often inaccurate, should it be abandoned?
  7. The Bank of England is forecasting that inflation will rise in the coming months. Discuss reasons why this forecast is likely to prove correct and reasons why it may prove incorrect.
  8. How could economic forecasters take the possibility of a Trump victory into account when making forecasts six months ago of the state of the global economy a year or two ahead?
  9. How might the use of big data transform economic forecasting?
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Economists: have we failed to communicate to the general public?

Before the referendum, economists overwhelmingly argued that the economic case for the UK remaining in the EU was much stronger than that for leaving. They warned of serious economic consequences, both short term and long term, of a Brexit vote. And yet, by a majority of 51.9% to 48.1% of the 72.1% of the electorate who voted, the UK voted to leave the EU.

Does this mean that economists failed to communicate to the electorate? Were the arguments presented poorly or in too academic a way?

Or did people simply not believe the economists’ forecasts, being cynical about the ability of economists to forecast? During the campaign, on several occasions I heard people repeating the joke that economists had successfully predicted five out of the last two recessions!

Did they not believe the data that immigrants from other EU countries to the UK contribute more in taxes they draw in benefits and that overall they make a net positive contribution to output per head? Or perhaps they believed the claims that immigrants imposed a net cost on the economy.

Or were there ‘non-economic’ issues that people found more persuasive, such as questions of sovereignty or national identity? Or was the strain on local resources, such as health services, schools and housing, blamed on immigration itself rather than on a lack of spending on additional resources – the funding for which could have come from the extra GDP generated by the immigration?

Or were there so many lies told by politicians and those with vested interests that people simply didn’t know whom to believe?

Economists will, no doubt, do a lot of soul searching over the coming months. One such economist is Paul Johnson, Director of the Institute for Fiscal Studies, whose article is linked below.

Article
We economists must face the plain truth that the referendum showed our failings Institute for Fiscal Studies newspaper articles. Paul Johnson (28/6/16)

Questions

  1. In what ways could economists have communicated better to the general public during the referendum campaign?
  2. For what reasons may people distrust economists?
  3. Were economists hampered in delivering their message by ‘balanced reporting’?
  4. Comment on Paul Johnson’s statement that, ‘The most politically engaged of us spend decades working out how to tweak tax policy, or labour market policy, or competition policy to deliver small benefits. How many times over would our work have been repaid if we had simply convinced a few more people of the basics?’
  5. Do economists, or at least some of them, need to become more ‘media savvy’?
  6. How could institutions, such as the Royal Economic Society and the Society of Business Economists, do more to help economists collectively to communicate with the general public?
  7. Give some examples of the terminology/jargon we use which might be inappropriate for communicating with the general public. Suggest some alternative terms to the examples you’ve given.
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Gloomy assessments of the global economic outlook

In two posts recently, we considered the pessimistic views of Robert Peston about the prospects for the global economy (see Cloudy skies ahead? and The end of growth in the West?). In this post we consider the views of Christine Lagarde, Managing Director of the International Monetary Fund, and Lord Adair Turner, the former head of the Financial Services Authority (FSA) (which was replaced in 2013 by the Financial Conduct Authority and the Prudential Regulation Authority).

Christine Lagarde was addressing an audience at Georgetown University in Washington DC. The first four links below are to webcasts of the full speech and subsequent interviews about the speech. She gives a more gloomy assessment of the global economy than six months ago, especially the eurozone economy and several emerging economies, such as China. There are short- to medium-term dangers for the world economy from political conflicts, such as that between Russia and the West over Ukraine. But there are long-term dangers too. These come from the effects of subdued private investment and low infrastructure spending by governments.

Her views are backed up by the six-monthly World Economic Outlook, published by the IMF on 7 October. There are links below to two webcasts from the IMF discussing the report and the accompanying datasets.

In the final webcast link below, Lord Turner argues that there is a “real danger of a simultaneous slowdown producing a big setback to growth expectations.” He is particularly worried about China, which is experiencing an asset price bubble and slowing economic growth. Other emerging economies too are suffering from slowing growth. This poses real problems for developed countries, such as Germany, which are heavily reliant on their export sector.

Webcasts
The Challenges Facing the Global Economy: New Momentum to Overcome a New Mediocre IMF Videos, Christine Lagarde (full speech) (2/10/14)
Christine Lagarde downbeat on global economy BBC News Canada, Christine Lagarde interviewed by Katy Kay (2/10/14)
IMF’s Lagarde on Global Economy, Central Banks Bloomberg TV, Christine Lagarde interviewed by Tom Keene (2/10/14)
Lagarde: Global economy weaker than envisioned 6 months ago, IMF to cut growth outlook CNBC (2/10/14)
IMF Says Uneven Global Growth Disappoints IMF Videos, Olivier Blanchard (7/10/14)
Time Is Right for an Infrastructure Push IMF Videos, Abdul Ablad (30/9/14)
China slowdown poses ‘biggest risk to global economy’ The Telegraph, Adair Turner (4/10/14)

Articles
Global Growth Disappoints, Pace of Recovery Uneven and Country-Specific IMF Survey Magazine (7/10/14)
Global economy risks becoming stuck in low growth trap The Telegraph, Szu Ping Chan (2/10/14)
American Exceptionalism Thrives Amid Struggling Global Economy Bloomberg, Rich Miller and Simon Kennedy (4/10/14)
World Bank cuts China growth forecast for next three years BBC News (6/10/14)
Beware a Chinese slowdown The Guardian, Kenneth Rogoff (6/10/14)
IMF says economic growth may never return to pre-crisis levels The Guardian, Larry Elliott (7/10/14)
IMF goes back to the future with gloomy talk of secular stagnation The Guardian, Larry Elliott (7/10/14)

Data
World Economic Outlook Database IMF (7/10/14)
World Economic Outlook IMF (October 2014)

Questions

  1. What are the particular ‘headwinds’ facing the global economy?
  2. Why is the outlook for the global economy more pessimistic now than six months ago?
  3. Why are increasing levels of debt and asset price rises a threat to Chinese economic growth?
  4. Why may China be more able to deal with high levels of debt than many other countries?
  5. In what ways are commodity prices an indicator of the confidence of investors about future economic growth?
  6. What are the determinants of long-term economic growth? Why are potential economic growth rates lower today than in the 2000s?
  7. How might governments today boost long-term economic growth?
  8. What are the arguments for and against governments engaging in large-scale public investment in infrastructure projects? What would be the supply-side and demand-side effects of such policies?
  9. If confidence is a major determinant of investment, how might bodies such as the IMF boost confidence?
  10. Why does the IMF caution against over-aggressive attempts to reduce budget deficits?
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