Hope filled economists and the hopelessness of economic forecasting

In November 2007, which Nobel prize winning economist*  said:

 “So I am skeptical about the argument that the sub-prime mortgage problem will contaminate the whole mortgage market, that housing construction will come to a halt, and that the economy will slip into a recession. Every step in this chain is questionable and none has been quantified. If we have learned anything from the past 20 years it is that there is a lot of stability built into the real economy.”

* Robert E. Lucas Nobel Prize winner 1995

Economic forecasting is a fraud. There are just too many variables.  Maybe the majority of human activities are economic variables. It is difficult to think of any which are not.

Given that almost all human activity has economic consequences how can we possibly know the future outcomes of the infinite combinations of variables acting on each other. Life (i.e. Life as in “Life is what happens when you’re busy making other plans”) and economic activity are inseparable,

Five years, two years, one year before it happened, how many economists forecast the current level of interest rates, the lowest interest rates for hundreds of years?  Ultra low interest rates, a key variable, will not have been fed into any economic models designed to predict future outcomes at any time in the past.  Garbage in garbage out.

The BOE interest rate setting committee argued for years about relatively trivial adjustments in the level of interest and inflation. All that work and reflection was been rendered irrelevant by the unanticipated credit contraction of the past two years.

The price of oil is another example of a key variable producing unanticipated outcomes. The 150$ barrel was no more anticipated in 2008 than the 25$ barrel in 1973. Energy prices are another key input of econometric modelling and forecasting.

Imagine a world in which economics were so developed that forecasts were accurate. Predicted outcomes happened. All economic variables could be effectively predicted and controlled to attain a specific economic objective. How would this be possible and at the same time for human beings to remain free?

Our economic life is inseparable from our existence and the consequences and effects of the economy touch every moment of human existence. If economic forecasting worked, would we need anyone other than economists in government?

Or would we have no need for government?


Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s