Forecasting errors

by
Peter Radford
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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.