The Crystal Ball Of ECONOMIC FORECASTING
How often has this happened to you? You've packed a tasty picnic lunch, donned your spiffy-looking swimwear, loaded up the beach blanket and umbrella, then headed for the artificial waves of the local Happy-Time Gala-World Fun-Land Water Park expecting bright sunshine and warm temperatures. However, upon reaching Happy-Time Gala-World Fun-Land Water Park you find that the economy has fallen into a deep recession, with high unemployment rates and sluggish production, and the owners of the Happy-Time Gala-World Fun-Land Water Park have been forced to turn off the artificial wave machine, dismantle the water slides, and drain the pool. (It's also raining and 50 degrees. We will, however, ignore those problems because this isn't A Pedestrian's Guide to Meteorology.)
If Only You Had Known
A big problem for most of us, as we saw with Fact 6, Our Unknown Economy, is that the future is, well, unknown. If only you had known that the price of OmniTech stock was going to triple, that a pickup truck was going to run that stoplight as you passed through the intersection, or that your high school prom date was going to develop an allergic reaction to pine tar and pickled herring (no time for details, but it wasn't a pretty sight), then your life would be a whole lot better.
While it's pretty tough to predict allergies and drivers' actions, serious efforts have been made in the realm of forecasting economic events. For example, stock brokers, speculators, and assorted investors spend a lot of time trying to predict stock prices for reasons that should be pretty obvious.
Less obvious may be the efforts of pointy-headed economists, statisticians, and others lovingly referred to as "number crunchers," who try to forecast all sorts of economic stuff, such as inflation, unemployment, production, income, and interest rates. Unlike the local weather guys, you seldom hear their names, but their forecasts often surface in newspapers, magazines, and the nightly news. More importantly, their efforts are used behind the scenes to help government and business leaders of the first two estates make decisions that involve gadzillions of dollars.
Although decisions affected by future economic events that are made by members of the third estate don't climb into the gadzillion dollar category, they can be pretty darn important. As such, it might be useful to know a little bit about this economic forecasting business.
Connecting the DotsLet's say that you've been given four numbers -- 2, 4, 6, 8 -- and you need to make a guess about the fifth. You don't need a room filled with high speed, mega-capacity computers to come up with the number 10. All you have to do is "extrapolate the trend." Sometimes this is a pretty good way of making a forecast. If Master Sprocket's convenience store has 2 customers on Monday, 4 on Tuesday, 6 on Wednesday, and 8 on Thursday, then there's a good chance that 10 customers will show up on Friday.
It can also, however, be dangerous if you don't know why the numbers went from 2 to 4 to 6 to 8. Did the number of customers increase on each subsequent day because Master Sprocket's kept lowering the price on its quick-frozen semi-nutritious deli sandwich? Or perhaps Captain Car-Hop, a close competitor, was running out of an essential product like, let's say, gasoline, increasingly forcing its customers to seek out alternatives.
You Gotta Have a Theory
The inherent danger of extrapolating an historical trend, means that most economic forecasting is based on some sort of theory. Forecasters try their best to figure out what causes what and thus to explain why and how different events occur in our economy.
- Did the inflation rate go up? Why? The money supply? Government spending?
- Did the economy's production pie grow last year? Why? Technology? Labor? Capital?
- Did the interest rate decline? Why? The federal deficit? Consumer borrowing?
If forecasters can figure out why the economy went this way or that way last year, then they have a much better chance of guessing where it will go next year.
If the customer count at Master Sprocket's went from 2 to 4 to 6 to 8 because the price of quick-frozen semi-nutritious deli sandwiches went from $2.00 to $1.80 to $1.60 to $1.40, then we can make a pretty good guess about the number of customers on Friday, if we know the price of quick-frozen semi-nutritious deli sandwiches. A 10-customer forecast would be out of line if the price of quick-frozen semi-nutritious deli sandwiches jumps back to $2.00.
Life's a Gamble
Economists and economic forecasters have developed some very elaborate theories over the past 200 years to improve their forecasts. They look at hundreds, even thousands, of different parts of the economy to see how everything fits together. But (and here's another one of those important "buts"), forecasters are only able to come up with educated guesses. They can never know for certain what will happen before the fact.
To illustrate why, let's say that you're flipping a two-headed coin. It should have a 100 percent chance of coming up heads, right? Not necessarily. It could come to rest on it's edge, fall through a crack in the floor, or be swallowed by a very, very large cockroach. If you predict that the coin will land heads up, then you have a pretty good chance of being right. But, NOT a 100 percent chance.
Unfortunately for those who make a living doing this forecasting thing, the economy is fraught with a great deal more uncertainty than a two-headed coin. If forecasters can get within 90-95 percent of being right, then they're pretty darned pleased with themselves.
Here are three reasons why you should consider economic forecasts as educated guesses:
- All sorts of unpredictable things like natural disasters, wars, and irrational government policies can screw up even the best economic forecasts.
- Sometimes forecasters use bad theories. Politicians, in particular, tend to dredge up forecasters who use bad economic theories. Incumbent politicians, hoping to remain incumbent, try to get the most optimistic forecasts possible -- whether or not they have any validity. Aspiring, nonincumbent politicians tend to uncover bad theories that give the most pessimistic forecasts, hoping that they can convince voters to see deficiencies, real or not, with the incumbent.
- Errors, no matter how small, tend to multiply. Even if you're 99 percent certain that you can separately forecast ten different things like the interest rate, inflation, and unemployment, you can only be 90 percent certain of accurately forecasting all ten of them at once. In that the economy is complex and highly interactive, if forecasters miss on one tiny little item, then everything they forecast can be off the mark.
Now for few tips to consider if you use an economic forecast:
Cautionary Tips on Economic Forecasts
- Just because some government official or business leader with an impressive-sounding job title reports that production or interest rates are expected to go up or down, doesn't make it so. All forecasts are guesses, some are just better than others.
- Forecasts are like any consumer good, shop around to find the best. This doesn't mean that you should run to the library every time a nightly newscaster reports on a recently released economic forecast. However, if you're considering a big decision, like changing careers, buying a house, or investing in the stock market, then look for several forecasts -- your public library should have some. If you make a major decision based on a bad forecast, then you stand to lose your shirt or ruin you life.
- Along the same line, it wouldn't hurt to question the source of any publicized forecast. Of course, politicians are prone to play up forecasts that are most likely to help them achieve the political aspirations. Others can be just as guilty. If you're considering an investment in stocks, bonds, gold, silver, or any other financial market, be wary of forecasts supplied by brokers who earn a living from the transactions. They say the price is headed up, but they get their fee when you invest whether the price goes up or down.