Earlier this week we posted Nums: Why’s the Fed so bad at forecasting?
We cited Nate Silver’s thesis that economists’ forecasts are generally poor for 4 main reasons:
- Complexity makes it hard to to pin down cause & effect.
- The economy is dynamic, especially subject to policy jolts
- Economic data is imprecise and subject to large revisions
- Forecasts often reflect political bias … pro and con.
On cue, the Feds released released their revision to Q1 GDP …
Based on revised data, the economy grew at a 1.8% annual rate in the first quarter, well below previous estimate of 2.4% growth.
The biggest change was a cut in the government’s estimate of consumer spending which is more than 70% of the economy.
Consumer spending growth dropped to 2.6% from 3.4% growth.
Source: USA Today
The revision — .6% – may initially sound like loose change, but it’s a 25% miss.
So, economic models that operating on the original (higher) estimate have a starting point that is off by 25%.
The error compounds over time.
It’s a version of what theorists call chaos theory … how a seemingly small variation at a starting point can compound into a major effect over time.
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Side note: And, in the “new normal” economy, the downward revision was good for the stock market since it puts pressure on the Fed to continue pumping money into the economy … the bulk of which is flowing straight to the stock market.