Economists have had an awful record of forecasting inflation, interest rates, gross domestic product, and other macro variables, writes Chris Edwards of the CATO Institute. He continues (abridged):
Contrary to the confident‐sounding claims of experts in the media, economists cannot accurately predict the macroeconomy. Economists have an awful record at forecasting inflation, interest rates, gross domestic product, and other macro variables. Below I excerpt from a Wall Street Journal column summarizing the failed record of forecasting 2022’s inflation, interest rates, and stock market.
This is important for public policy because if economists cannot predict the macroeconomy, then governments cannot successfully intervene and manipulate. The administration thought that its $1.9 trillion American Rescue Plan passed in March 2021 would aid the economy, but it proved to be hugely damaging by helping to spur high inflation.
Businesses and stock market investors often make mistakes, but they can change direction quickly as conditions change. The government, by contrast, is a rigid institution led by people who rarely admit mistakes. So when politicians move economic resources around, the resources usually get stuck in low‐value uses for years on end, as discussed in this study on government failure.
The Wall Street Journal reports that while economists projected corporate profits accurately this year, they were far off in projecting the stock market, inflation, and interest rates:
“The average forecast last December for this month’s interest rate was just 0.5%, according to Consensus Economics. The Fed this month raised rates to a range of 4.25% to 4.5%. Miss a change of this importance and there is little hope of getting anything else right.
Few even called the direction of stocks correctly. JPMorgan, Goldman Sachs and Citigroup were all bullish, expecting the S&P 500 to hit 5100, 5050 and 4900 respectively. Bank of America‘s strategists were rightly bearish, for the right reason, predicting a rates shock. But their 4600 target was a drop of just 3% from when they published their prediction. The S&P 500 closed on Friday at 3844.82, down 19% for the year so far.
Underlying all these errors, and those from pretty much everyone else, was the mistaken belief that inflation would quickly go away. Covid‐related supply‐chain problems would fade away, they thought, and falling inflation would allow the Fed to raise rates gently, sparing asset prices. Instead, inflation spread to virtually all categories of goods and services, worsened by the energy‐ and food‐price spikes that followed Russia’s invasion of Ukraine.”
If they cannot successfully manipulate the economy, then what should governments do? Economist Adam Smith advised them to adopt the “simple system of natural liberty.” By refraining from intervening:
“the sovereign is completely discharged from a duty, in the attempting to perform which he must always be exposed to innumerable delusions, and for the proper performance of which no human wisdom or knowledge could ever be sufficient; the duty of superintending the industry of private people, and of directing it towards the employments most suitable to the interest of the society.”