About Those Mad Egomaniacs We Call Economists

“Anyone who believes in indefinite growth in anything physical, on a physically finite planet, is either mad or an economist.”
― Kenneth E. Boulding

Yes it is always easy to poke fun at economic forecasts, especially because they usually turn out to be wrong, often by a large margin. However, before laughing them off, think about what is being asked of those forecasts and the economists making them by considering the below analogy.

I presume that most of you reading this own a car and have a license to drive it. The license certifies you to be minimally competent drivers, sort of the way a Ph.D. certifies an economist to have a minimal command of economics. Nonetheless, it is very easy to prove that you are all incompetent fools who know nothing about how a car works or how to drive it and thus to prove that drivers’ licenses are a big joke. Answer the following simple question: What will be the Mercator grid coordinates of your car exactly 2,190 hours from now (that’s three months), what direction will it be traveling, and how fast will it be going? You obviously don’t know. I have just proven that you are an incompetent driver and a fool deserving of ridicule because you claim to know the basics of how a car works and how it is to be used.

Asking an economist to predict where GDP (a far, far more complicated object than any car) will be in 3 months or a year and then ridiculing him for getting it wrong is exactly the same. An economist can tell you a lot about what makes GDP move around. Asking him to predict where GDP will be some months in the future, what direction it will be going, and how fast it will be going that way is very different. It is asking for an unconditional forecast without providing any information about what the driver (the American people and their government) wants to do, whether he will step on the brake or the accelerator, whether he will have the gears in forward or reverse, and so on. Of course economists get it wrong, and often wildly so, just the way you can’t answer my question about your car.

The problem is that economists take these predictions so seriously, and so do politicians and investors. I think you might agree that the statistical probability that we will not have a recession in the US for the rest of the decade is quite low, yet not one budget projection assumes a slowdown, let alone a recession, which would absolutely devastate any budget as far as deficits are concerned. We act as if the business cycle has been repealed by an act of Congress.

I understand why we do forecasts. As humans, citizens, politicians, businessmen, and investors, we have to plan. I am guilty of making forecasts myself. However, if we do not want to be judged on our forecasting abilities, then we should not prognosticate, at least not in public. And we certainly shouldn’t make our predictions sound so certain to the general public.

Remember the November 2008 stock market crash around the world? “How come none of those luminary economists could foresee it?”

If you’ve suspected all along that economists are useless at the job of forecasting, you would be right. Dozens of studies show that economists are completely incapable of forecasting recessions. But forget forecasting. What’s worse is that they fail miserably even at understanding where the economy is today. And this is true not only for official organizations like the IMF, the World Bank, and government agencies but for private forecasters as well. They’re all terrible. In plain English, economists don’t have a clue about the future.

And if you think the Fed or government agencies know what is going on with the economy, you’re mistaken as well. Government economists are about as useful as a screen door on a submarine. Their mistakes and failures are so spectacular you couldn’t make them up if you tried. Yet now, in a post-crisis world, we trust the same people to know where the economy is, where it is going, and how to manage monetary policy.

Central banks say they will know the right time to end the current policies of quantitative easing and financial repression and when to shrink the bloated monetary base. However, given their record at forecasting, how will they know? The Federal Reserve not only failed to predict the recessions of 1990, 2001, and 2007, it also didn’t even recognize them after they had already begun. Financial crises frequently happen because central banks cut interest rates too late and hike rates too soon.

Trusting central bankers now is a big bet that (1) they’ll know what to do, (2) they’ll know when to do it. Sadly, given the track record, that is not a good wager. Unfortunately, the problem is not that economists are simply bad at what they do; it’s that they’re really, really bad. They’re so bad that it cannot even be a matter of chance.

If economists’ forecasts were as accurate as they claimed, we’d expect the actual value for GDP to fall within their prediction interval nine times out of ten, or all but about twice in eighteen years.

In fact, the actual value for GDP fell outside the economists’ prediction interval six times in eighteen years, or fully one-third of the time. Another study, which ran these numbers back to the beginning of the Survey of Professional Forecasters in 1968, found even worse results: the actual figure for GDP fell outside the prediction interval almost half the time. There is almost no chance that economists have simply been unlucky; they fundamentally overstate the reliability of their predictions.

Bottom line: Why do people listen to economists anymore? Scott Armstrong, an expert on forecasting at the Wharton School of the University of Pennsylvania, has developed a “seer-sucker” theory: “No matter how much evidence exists that seers do not exist, suckers will pay for the existence of seers.” Even if experts fail repeatedly in their predictions, most people prefer to have seers, prophets, and gurus tell them something – anything at all – about the future.

Now think of the vast powers Fed economists have to print money and move interest rates. When you contemplate the consummate skill that would actually be required to manage post-Great Recession policies, you realize they’re really just flying blind. If that reality doesn’t scare the living daylights out of you, you’re not paying attention.

The longer the Federal Reserve sticks to its current policy, the more likely that policy will end in tears.

Share your thoughts…

Written by

Ziad K Abdelnour, Wall Street financier, trader and author is currently President and CEO of Blackhawk Partners Inc., a private equity and physical commodities trading firm based out of New York City, Founder & President of the United States Committee for a Free Lebanon (USCFL), Founder & Chairman of the Financial Policy Council, Member of the Board of Governors of the Middle East Forum and Former President of the Arab Bankers Association of North America.