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The Illusory World of Economic Forecasting

Paul Farrell (who's been on an angry tear lately) states what we have all known for quite sometime: Economists make awful forecasters. Farrell calls it "the illusory world of economic illusionists."

We've discussed this issue several times in the past: 1) in general with The Folly of Forecasting; and B) specifically, with The Mystery of the Awful Economists.

William Sherden did research on the accuracy of leading forecasters over a few decades, and his findings were summarized in his book "The Fortune Sellers: The Big Business of Buying and Selling Predictions." And his conclusions are still accurate: 

"They are timeless. The political influence on predictions is basic human nature. I see no way that economic forecasting can improve since it is trying to do the impossible."

Here are Sherden's top 10 findings in The Fortune Sellers:

1. The forecasting skill of economists is on average about as good as guessing. In fact, predictions by the politically driven Council of Economic Advisors, Federal Reserve Board and Congressional Budget Office were often worse than guessing.

2. Economists cannot predict the turning points in the economy. Of 48 predictions made by economists, 46 missed the turning points.

3. Economic forecasting accuracy declines with longer lead times.

4. No economic forecasters consistently lead the pack in accuracy.

5. No economic ideology consistently produces superior forecasts.

6. No economic forecaster has consistently higher forecasting skills predicting any particular economic statistic.

7. Consensus forecasts do not improve accuracy (although the press loves them).

8. Psychological bias affects forecasters and their forecasts. Some economists are naturally optimistic and bullish, others are consistently pessimistic bears.

9. Increased sophistication provides no improvement in forecasting accuracy. Remember the Long-Term Capital Management hedge fund? Two brilliant Nobel Economists backed by Wall Street's elite nearly sabotaged the world economy.

10. Finally, Sherden says there's no evidence that economic forecasting has improved in recent decades. In fact, forecasting appears to be deteriorating as partisan politics, Wall Street gaming and unpredictable global events invent new illusions.

The one caveat I would add to this is I have found ECRI to be consistently useful as an economic analysts, along with ISI and NDR. They help discern objective reality, rather than make forecasts per se.

Good stuff, Paul.

>

Source:
America's 'Hollywood economy'
Paul B. Farrell, MarketWatch
Marketwatch, 7:23 PM ET Sep 18, 2006
http://tinyurl.com/qxc7a

Tuesday, September 19, 2006 | 07:26 AM | Permalink | Comments (18) | TrackBack (0)
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Comments

I recently read Sheridan's "The Fortune Sellers." I think he overstates his case a little bit, but not nearly as much as most forecasters.

If, as you noted, "forecasters" spent more time on possibilities then on time sensitive predictions their input would be much more useful. Why on earth people think they can make time accurate predictions on systems with intelligent agents and feedback loops is beyond me.

Although your list covers many of Mr. Sheridan's points, I would still recommend the book to anyone who bases money decisions on ANY type of forecasting.

He has a whole chapter where he shreds the practice of forecasting company earnings. By implication, it could be taken that companies that consistently hit their numbers are suspect with regards to 'gaming' the system.

Russell

Posted by: Russell | Sep 19, 2006 8:14:46 AM