Why Are Mainstream Economic Forecasts So Often Wrong?

Every end of the year, by the end of the year, we receive numerous estimates of global GDP growth and inflation for the following year. Historically, almost in all cases, expectations of inflation and growth are too optimistic in December for the following year.

If we look at the track record of central banks, it is particularly poor in predicting inflation while large supranational entities tend to err on the side of optimism in GDP estimates. The IMF or the OECD, for example, have been particularly poor at estimating recessions, but mostly accurate at making long-term trend estimates. Contrary to popular belief, it seems that most forecasts are better at identifying long-term economic dynamics than short term ones.

Forecasting is a dirty job, but somebody has to do it. Economic forecasting is exceedingly difficult because there are numerous factors that can drastically change the course of a global economy that is increasingly complex and subject to important uncertainties. However, macroeconomic forecasting is also essential to provide a frame of reference for investors and policymakers. It should not be considered the revealed truth nor entirely dismissed, just an important framework that allows us to at least identify the major points of discrepancy as well as the areas to look at for positive or negative surprises as the year unravels. Yes, macroeconomic forecasting is essential.

The first lesson is that independent forecasts are almost every year more accurate than those of supranational bodies and central banks. There is a logic behind it. Independent forecasters do not feel the political pressure to use a benign view of government policies in their estimates. This is one of the main reasons why investors increasingly use their own economic forecasting teams alongside truly independent firms. While it is always worth paying attention to investment banks and international bodies’ forecasts, most investors have learnt to understand that the estimates of these large entities are often blurred by political correctness and a tendency to be overly diplomatic. Notice how even in countries where governments have destroyed the economy with wrong policies, one-year-ahead forecasts tend to be diplomatically optimistic.

1 2 3 4
View single page >> |

Disclosure: None

How did you like this article? Let us know so we can better customize your reading experience. Users' ratings are only visible to themselves.


Leave a comment to automatically be entered into our contest to win a free Echo Show.
Edward Smith 4 weeks ago Member's comment

Dear Mr. Lacalle, Your article is very interesting coming from my view as a financial advisor and student of domestic and foreign economics, stock/bond markets and geopolitical impacts. I read from a huge list of sources each month, but not to be able to espouse impressive statistics, if I could even remember them all. It's because, in my humble opinion, one must be a student of the aforementioned in order to understand risk and the requisite portfolio adjustments to consider for clients based on a 'homework rationale' approach. Your sentence on using different sources of research is spot on. I read your posts on Twitter regularly and enjoy them. When your article talks about inflation, in my opinion, and even though I have no level of training as you, both CPI and PCE need to be retooled. The Federal Reserve had a 'target' of 2% for a long time, and if I understand it correctly, they just changed that to seeking an 'average' of 2%. Yet, from what I've read, PCE has barely ever hit that number. To use an analogy, I'm a 15 handicap golfer. But, if I have a target to hit 12 or want to have an average of 12 is irrelevant if I haven't seen 14 yet, and that's what the Fed-speak tells me, they're disconnected in their communications. I've had clients invested in TIPS (among many other things), both US and foreign TIPS, for most of 2020 and have done well for them doing so. And that's because, to your point, I do my own homework. While the US Fed and politicians and too much of the media state that inflation is benign, and only recently admitting that it is starting to show up, it's already been here. Case in point, the US Bureau of Labor Statistics (BLS) report for CPI for 12 months ending October of this year. There are SO many consumer categories in that report that show their 12 month rates anywhere from +3% to +10%. Yet, energy is a high negative number which probably negates all of the others, so I assume the CPI weighting math is wrong. Yet, consumers don't spend the vast majority of their money at the gas pump, they spend it on food, clothing, on-line purchases, etc. so, in my opinion, the CPI data, and most likely PCE data that the Fed and politicians rely on, are both out of touch, or need to be rebalanced, or both. Accordingly, that data is what the politicians and the Fed rely on because it's probably politically inappropriate to do otherwise, and market impacts would be high to address it as the BLS reports it. So I continue to make returns for clients in inflation based investments as appropriate while I chuckle at Fed and political speak saying that it might show up someday. BLS data shows otherwise. And to me, they're talk on 5yr/5yr data and other mathematical views means they need to step out of their cubicles and do surveys on actual consumer costs in stores, on line, etc., since consumers make up something like 60% of US GDP? SO, if their understanding of inflation is off, might not their evaluation of GDP be the same? Anyway, this is my view, sir, and I very much enjoy your writings and learning from you. Please let me know if my understanding above is incorrect or how I should adjust it, if you have time. Very sincerely, Ed

Angry Old Lady 4 weeks ago Member's comment

Wow, that's quite a lot to pack into a single paragraph!

Edward Smith 4 weeks ago Member's comment

Sorry, it actually wasn't, I typed it as paragraphs and this program changed it into just one. Odd.

Angry Old Lady 4 weeks ago Member's comment

Lol, I know what you mean. That has happened to me sometimes if I edit a comment. Must be a bug.