Economic Forcasting Folly

Nearly every day we hear new economic predictions relating to a host of factors including economic growth, interest rates, stock market levels, currency and unemployment.  Often the economists, money managers, research bodies and market pundits have differing or contrasting views, other times a consensus view emerges.

Hugh MacNally has pointed out the flawed nature of economic predictions and the danger in relying on these forecasts.  His comments aroused my interest and an investigation with some help from Google and university research ensued.  Fortunately because it's easy to measure the accuracy of financial forecasts, there is plenty of material available.

The findings are surprising.  Expecting to confirm that economic forecasts were not terribly accurate and in general could not be relied on - Instead, what I discovered was that even among the most respected commentators, their predictions were no more accurate than a random role of the dice or the views of the general public.  In short, economic predictions are no more accurate than guesses.

The evidence to support these conclusions is substantial to say the least.  For those interested in finding out more I can suggest The Fortune Sellers by William Sherden who reviewed the many academic studies in this field and the regular prediction tables published by the Wall Street Journal.  In reviewing the research Sherden concluded:

  • Forecasters can not predict turning points in the economy
  • Forecasting accuracy decreases with the length of the prediction
  • Overall skill in economic forecasting is the same as random guesses
  • No individual forecasters have consistent accuracy
  • Consensus forecasts offer no improvements in accuracy
  • Economic forecasts have not increased in accuracy over the past 30 years.

The failure of forecasters to predict the GFC or the 20 year Japanese recession are good examples of forecasters missing even the largest economic developments.

Prediction errors are not just in missing downturns either, in May 2009 the Australian Treasury predicted that GDP growth for the 2009/2010 financial year would be negative 0.5%. The Reserve Bank of Australia and economists working for the banks all had similar forecasts.  The IMF was even more negative predicting a 1.4% contraction in the Australian economy. But GDP growth for 2009/2010 turned out to be positive 3.3%.

And no one predicted the 13% Australian share market rally over the past three weeks.

The other flaw in utilising economic forecasts in investment strategy is that these forecasts tell nothing about how individual companies are performing. 

Kris Vogelsong, November 2011