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Forecasting errors

from Peter Radford

I suppose forecasting errors is one of those phrases that needs a bit of explanation.  Are we forecasting errors?  Or are we discussing the errors in forecasting?  I think it’s both.

Take the current debate going on about Biden’s $1.9 trillion economic relief package.

A few notable economists, including both Larry Summers and Oliver Blanchard, are arguing that Biden is proposing on spending too much.  This criticism is not based on any analysis of the level of unemployment, the ability to pay rents, the likelihood of imminent re-employment, or any other issue of urgency.  It is based on the usual orthodoxy economists trot out year after year.  The argument is this: the economy was not in distress prior to the pandemic, meaning there were none of those infamous “imbalances” that economist love to talk about; so it ought to bounce back quickly once the emergency lets us all get back to whatever we were doing before we so rudely interrupted; that it is in pretty good shape despite the headline closures, loss of jobs, and other ephemera of the crisis is shown by the facts that households still have pretty good bank balances and that consumer debt is also low[ish], meaning that there is plenty of cash around to splurge when splurging is OK once more.

This line of reasoning is good as far as it goes.  The economy has no big fundamental problems.  Households have resources to spend.  All we are waiting for is the opportunity to spend.

But then along comes Biden and tosses a wad of cash into this mix, which gets the orthodox on high alert.

Why?

Because in their  models of how economies work, that extra cash is actually unnecessary.  Since the economy is basically OK, we don’t need to get too fancy in a relief package.  There’s lots of cash kicking around already.  So this extra injection of cash won’t show upon as a surge of economic activity, it will show up as a surge in prices.  That extra cash won’t have any particularly productive place to go, so it will end up, in the words of the older sages, being “too much cash chasing too few goods”.  AKA inflation.

This risk of inflation will then, the orthodox logic goes, cause the Federal Reserve Board to raise interest rates in order to fight back.  The net effect being that the Fed will be forced to take away what Biden just gave.  And this looks, to the orthodox eye, as a waste of time and effort.  So why not reduce the relief package and avoid the problem?

How very sensible.

Except …

Orthodox economists have a fairly rotten record of forecasting what’s going on.  In fact their record is more than rotten.  They consistently over-estimate what they economy is likely to do — their projections of GDP have been routinely optimistic for ages — and so they are equally consistently too concerned about the risks of inflation.  In only three of the years since 2006 has the average professional forecaster under-shot the outcome.  The economy seems constantly to be worse than they project.

This might all sound very academic, but it has real-world consequences.  You and I need to be concerned any time the orthodox get too worried about bouts of inflation.

Why?

Because their obsession with inflation influences policy recommendations that produce less than full employment.  There are jobs at stake.  People’s livelihoods, and their ability to escape a financially precarious situation, depend on the prognostications of economists with enough heft to shape policy.  Economists like Summers and Blanchard in fact.

So we are presented with a dilemma.  Do we go along with the caution of the orthodox economist and their perennial forecasting errors?  Or do we ignore them and forecast errors in their thinking?

I say the latter.

Policy makers have fallen far too short over the years in achieving what ought to be a primary goal: full employment. The economy was finally bumping along at full employment just before the pandemic wrecked everything.  But between the Great Recession and last year there were far too many years of sub-optimal employment rates.  The biggest reason?  The excessive emphasis that orthodox economists place on the possibility of an over-heated economy producing inflation.  So excessive was this emphasis that we never actually arrived at a point to test their ideas.  We under-performed for over a decade.

Of course, we have to add in that orthodox economics provides a useful intellectual prop for right of center ideologues who want to limit government involvement in the economy and reduce government spending.  The unholy alliance of economic orthodoxy and right of center politics cramped job growth for a long time.  Which is why it is odd to see two erstwhile center/center-left economists like Summers and Blanchard get lost in the “watch out for inflation” narrative.

It just goes to show how little space there is between the various flavors of economic orthodoxy: the differences are more arcane and less significant than the protagonists proclaim.

Anyway, we, the public, attuned as we are to the likely error in the forecast of these eminent economists can ignore their advice and go with Biden.  It’s a safe bet.

$1.9 trillion sounds about right.

  1. Gerald Holtham
    February 12, 2021 at 5:39 pm

    We never know exactly where the economy is or what the quantitative response will be to any stimulus. Right now, there is a majority among economists who hold that prudence is more risky than boldness. That is to say the downside risks are greater than the upside risks of doing too much. That is why a majority are backing Biden. Even Summers isn’t saying categorically that the package is too much. He knows he doesn’t really know.

  2. February 15, 2021 at 8:49 am

    It’s not just spending AMOUNTS that we ought to be concerned about, but what money is spent UPON. There already is inflation, just in the asset markets, and other mostly speculative – read: bubble-prone – markets. The S&P has been disconnected from the real economy for years, decades even, while real wages of the working class who make money while awake, has been stagnant for nearly 50 years, inflation-adjusted.
    And it’s getting worse. Gamestop millionaires are engaged in a zero sum game, or worse, because their mathematical skills are absent from the real economy.
    Infrastructure, actual new businesses that produce goods and services, even net new housing, are all in decline (in some Manhattan neighborhoods, unit consolidation outweighs development of new units). Poverty and near poverty describe the lifestyles of more than 50% of Americans. Schools are not just failing, but now actually closed to children, at least in the public sector, though not in the more privileged – again! – private sector.
    Measuring national wealth by GDP misses the point that it is a narrow, and narrowing, sliver that has the bulk of GDP.
    Biden’s policies are an attempt to right the ship, but without doing something about rent-seeking, they will fail to stem the ever upward suck of wealth to the top.

  3. Ken Zimmerman
    February 28, 2021 at 5:51 am

    Peter, your view of economists is much, much more generous than mine. Power hungry, in economics only because they cannot succeed at anything else, greatly inflated egos, hooked on the teat of big university and corporate salaries, and star struck with the shining ‘city on a hill’ of capitalism, socialism, ***ism is my description of economists. They are a waste of time, a waste of resources, and most certainly a destructive influence on society and the lives and futures of each of us without the riches of the top 1% or even top 10% to defend ourselves. My recommendation: send them to play in sandboxes where they can do no one except sand worms any harm.

    Also, I take issue with several of your premises.

    “This line of reasoning is good as far as it goes. The economy has no big fundamental problems. Households have resources to spend. All we are waiting for is the opportunity to spend.”

    The US economy is fundamentally fractured and has been almost from day one of the nation. With slavery, indentured servitude, crushing class, gender, and racial oppression, and at best a proto-democratic nation. As an historian I recognize these should be considered in context. But even in context, they make American economics barely tolerable for the vast majority of the nation’s residents. For many Americans life is, in the words of Thomas Hobbes, ‘Nasty, brutish and short.’ But, again in context during much of American and European history this situation was widespread. In America, several religious, social, and political movements alleviated some of the suffering, but even today there are Americans who insist that one’s status in life is one’s own doing, with no other explanation possible. It seems sometimes that many economists are among these Americans. It often seems those seeking to change the brutish circumstances of American economic life always encounter opposition from economists declaring ‘too much, too quickly.’ A message common with tenant landlords, factory owners, labor union opponents, colonial planters, some of today’s conservatives, and most of today’s Republican Party. Those who see birds of a feather flocking together see the truth, in my view.

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