Nums: Why’s the Fed so bad at forecasting?

Wash Post had an interesting analysis this week titled “This graph shows how bad the Fed is at predicting the future

The crux of their argument: the Fed has a clear recent tendency to mis-forecast economic growth … not by a little, by a lot …  forecasting almost twice as rapid growth as is ultimately realized.

For example,  in 2009 the Fed was predicting 4.2 percent growth in 2011.  But then in 2010 it revised that down to 3.85 percent growth. And in 2011 they revised it further to 2.8 percent growth. And when all was said and done, the economy only grew about 2.4 percent that year. The Fed projected growth almost twice as fast as what actually happened.

 

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What’s going on?

 

 

First, it’s not just the Fed … economists generally have a spotty track record forecasting.

For example, Nate Silver – in his book The Signal & the Noise – points out that:

Economic forecasts are blunt instruments at best, rarely being able to anticipate economic turning points more than a few months in advance.

Fairly often, in fact, these forecasts have failed to “predict” recessions even once they were already under way: a majority of economists did not think we were in one when the three most recent recessions, in 1990, 2001, and 2007, were later determined to have begun.

Economists predicted only 2 of the 60 recessions around the world a year ahead of time.

What’s the problem?

Silver chalks it up to a couple of  “challenges”:

First, it is very hard to determine cause and effect from economic statistics alone.

Although economists have a reasonably sound understanding of the basic systems that govern the economy, the cause and effect are all blurred together, especially during bubbles and panics when the system is flushed with feedback loops contingent on human behavior.

Second, the economy is always changing, so explanations of economic behavior that hold in one business cycle may not apply to future ones … especially if government policy is changing

Once policy makers begin to target a particular variable, it may begin to lose its value as an economic indicator.

For instance, if the government artificially takes steps to inflate housing prices, they might well increase, but they will no longer be good measures of overall economic health.

Third, as bad as their forecasts have been, the data that economists have to work with isn’t much good either.

A major challenge for economic forecasters is that their raw data isn’t much good.

Most economic data series are subject to revision, a process that can go on for months and even years after the statistics are first published.

The revisions are sometimes enormous.

Finally, there’s good old political bias.

The economic forecasts produced by the White House, for instance, have historically been among the least accurate of all,

= = = = =

Bottom line: The Fed isn’t alone …

Thanks to AR for feeding the WaPo lead

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