Here’s a prediction: 2016 economic forecasts are no more likely to be correct than they have been in 2015.
Global growth expectations for 2015 have been marked down, while inflation in advanced economies has been much weaker than projected. This exists despite unforeseen stimulus measures from some central banks (the Eurozone and China) and low-for-longer interest rates from others (the U.S. and UK).
Some of the events that have shaped the world economy in 2015, and which could continue to influence it for years to come, were off most economists’ radars at the start of the year. These include sharp falls in commodity prices and large-scale migration into Europe from Syria, Afghanistan and elsewhere.
This is not a new phenomenon. Economists’ reputation for predicting the future probably ranks alongside that of weather forecasters and fortune tellers. But there is still a demand for economists’ services.
Why, then, are we so bad at predicting what is going to happen? What predictions for 2016 does this sobering self-awareness lead us to?
In an uncertain world, forecasting errors are inevitable. Predictions can be knocked sideways, up, or down by events that are familiar but cannot be predicted in advance. These include changes in the supply of oil, fluctuations in harvests or political surprises. Projections can also go awry because of technical errors, such as forecasting models. Models can exclude variables which turn out to have a strong influence on economic behavior.
In an uncertain world, forecasting errors are inevitable.
Over time, we would hope to learn from such mistakes, and improve forecast accuracy. But economists are not the only profession to get their predictions wrong. So could there be some common behavioral traits underlying the dry, technical explanations?
One possibility is excessive confidence in our own predictive powers. As UK Monetary Policy Committee member Ben Broadbent has noted, experiments show that people who have reported being “100% certain” of something turn out, on average, to be correct only 70-80% of the time.
Another is the tendency, with hindsight, to exaggerate the probability we had assigned to events that did occur, and understate the likelihood attached to things that did not. This is a variant of the “stopped clock” phenomenon. Even a broken watch tells the correct time twice a day.
The International Monetary Fund (IMF) has noted that economists tend to be excessively optimistic about the future, systematically over-predicting growth rates in the period 1990-2007. The IMF suggests that this trait may reflect natural selection. We exist against the odds, so let’s celebrate!
If this is what we do, and why we do it, the next step is surely to correct our biases – or at least try to. Focusing not only on central forecasts but also the risks around them is exactly what economists have done more of in the aftermath of the global financial crisis.
Firms, central banks and investors can then check how well business, policy and investment strategies perform in scenarios beyond the baseline. Studies show that some professions are more realistic about their predictive powers than others – weather forecasters apparently score better than doctors. This is because regular feedback from users about forecast and scenario accuracy could also be performance enhancing.
Bearing these lessons in mind, what will happen to the world economy in 2016? First, central banks are likely to remain of the view, eight years on from the financial crisis, that the risk of doing too little outweighs the risk of doing too much. In this environment, interest rates should remain at exceptionally low levels and fresh stimulus measures are possible.
Second, while an outright currency war is unlikely – given that it would ultimately damage all – a currency war of attrition is another matter. Finally, history could be rewritten. Growth estimates are often revised as statistical agencies receive new information, and these revisions can be sizeable.
Economic forecasts can perform poorly at times because it is not easy making informed guesses about where the world economy is going when you do not know exactly where the primary information has come from. Now that is something to wonder.
*Forecasts are offered as opinion and are not reflective of potential performance, are not guaranteed and actual events or results may differ materially.
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