Must Economic Forecasts Always Fail?

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In the National Public Radio broadcast “Can Economic Forecasting Predict The Future?” Adam Davidson and Alex Blumberg report that “economic forecasters, even the best, have a mixed record forecasting the economy.” And “forecasters, at best, can say the economy will be somewhere between bad and good. And at worst, well, they missed something huge.”

Davidson and Blumberg interview Joel Prakken, chairman of Macroeconomic Advisors, who demonstrates the company’s mathematical modeling software used to forecast economic growth. The models are complex (“447 pages of really dense math equations”) and rely on vast amounts of historical data from the U.S. Bureau of Economic Analysis. So why the glum assesment?

Blumberg points out that “On average, the leading forecasters, like Prakken’s Macroeconomic Advisors, have around a one percentage point margin of error….” The difference between a national growth rate of one percent and three percent is the difference between a fairly good year and a bad one. In the interview, MIT’s Simon Johnson, who should know from his time at the IMF, comments: “You know, economic forecasting is inherently an impossible task.”

Does that mean forecasts and estimates are irrelevant? No. As Johnson puts it, “… businesses, the institutions, all involve thinking about the future and planning for the future. And you can’t do that without taking a view of the future.” If forecasts are so unreliable, how should businesses plan for the future?

“Why Forecasts Fail. What to Do Instead,” in the new MIT Sloan Management Review, presents a number of ways for managers to understand the problems inherent in forecasts and they argue for simple statistical techniques over complex modeling. Recognizing that managers need to make decisions on what they think will happen in the future, the authors outline their advice: “Accept that you’re operating in an uncertain world; Assess the level of uncertainty you face; Augment the range of uncertainty.”

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