Wednesday, 2 May 2018

Forecasts


People don't trust economic forecasts, but many simply don't understand what they are. They’re a bit like weather forecasts – a prediction of what will happen in a very complex system for which you don’t have all the data (as it’s very complex). The further you forecast, the less accurate it is, and a small variation in one of the key metrics can have an enormous effect down the line.

The crucial difference between a weather forecast and an economic forecast is that with an economic forecast you can fiddle with reality; however, the forecast itself is based on the system being self-contained and not changing - you can't add a bit of rain or snow to a weather forecast, although anthropoghenic warming can have a long-term effect, but you can change interest rates or implement some quantitative easing within an economy.


You simply cannot look at an economic forecast and compare it with reality further down the line and say it was wrong when some of the levers have been adjusted during the time interval. A forecast only remains reasonably accurate if there are no material changes to the economic levers. It's a bit like saying your Waze ETA was miles out when you actually diverted from your intended route by an hour because of a traffic accident. Your ETA only remains valid only if you stay on your intended route and nothing unexpected happens. If you deviate, then you have to do another final ETA when you leave your waypoint.

Another thing to bear in mind is that the Treasury forecast is done by the Treasury. The Governor of the Bank of England, who sets interest rates, is not a member of the Treasury. He is independent and the Treasury cannot predict the actions of an independent entity in the setting of interest rates.


2 comments:

  1. So.. When the Brexit vote happened and we voted to come out, why did the 'forecasters' not anticipate the stock market would surge ;I think they forecast it to drop.
    It all seemed logical afterwards when the 'experts' said it was a consequence of the pound dropping.
    You could say this was bound to happen if the vote went that way, but I never saw that prediction.
    If the vote had gone the remain way,then presumably the stock market would have remained more or less as it was.
    It would have been more or less a win/win situation as you couldn't foreseeably lose.

    ReplyDelete
    Replies
    1. Treasury and ‘Economists For Brexit’ forecasts were equally wrong - in opposite directions. The vast majority between these two were relatively accurate - IMF, OECD and NIESR.

      After the referendum, the Bank of England cut interest rates and increased its levels of asset purchases (quantitative easing). This acted as a shock absorber. The government also loosened the public spending purse strings in the Autumn Statement that followed the referendum, providing a fiscal boost.

      Better global growth has helped, alongside that monetary and fiscal stimulus. And, of course, we're still in the EU.

      Nevertheless, we have not performed as well as if the referendum had never happened and it has applied a brake to the UK economy.

      Delete