Thursday, September 07, 2006

Economics: The Dismal (Non) Science

Marton Fridson, writing at TCS Daily, pours some "Rain on the Economic Forecasters' Parade":

Investors are keenly interested in the pronouncements of economic forecasters, judging by the massive amounts of ink and airtime allotted to them by the media. It doesn't necessarily follow, however, that heeding the prognosticators is useful in selecting securities. Whether or not seers have insight into future conditions is a testable proposition. If it turns out that they don't, governmental attempts to guide the economy also come into question. Such efforts, after all, rely on forecasts generated by the same methodology that private-sector economists utilize.

Statistics compiled by Bloomberg L.P. shed light on the success of prominent forecasters. Each month, the financial information company surveys 60-plus economists from business and academe. The respondents handicap key indicators for the current quarter (which will not be reported until after quarter-end), and for the next four quarters. Among several indicators covered in the survey, I'll focus on gross domestic product (GDP), the most popular measure of aggregate economic activity. . . .

[The forecasters] overestimated current-quarter GDP 15 times and underestimated it just 6 times, with one bulls-eye. . . .

[D]uring 2001-2006, the year-ahead forecast hardly varied from one year to the next. The median prediction was in the range of 3.1% to 4.0% in every single quarter. Perhaps not coincidentally, the actual quarterly GDP increase over the past 25 years (1981-2005) averaged 3.14%. The forecasters, in aggregate, perennially thought that one year hence, business conditions would be just about average. In reality however, actual GDP gains gyrated between 0.2% and 7.5%. The forecasters' nearly inert consensus was all but worthless. . . .

As for government policymakers, the message is to forget about trying to control short-run economic performance. Given the lagged impact of fiscal or monetary intervention, deciding whether stimulus or restraint is needed depends on knowing where GDP will be a few quarters down the line. That isn't something economists have shown they can reliably predict. A more appropriate mission for government policy is to refrain from meddling that ultimately undermines confidence among business and consumers.

Fridson corroborates my similar critique of macroenomic forecasting (first link below). But the failure of economics as a quantitative discipline runs deeper than its inability to model macroeconomic activity with any degreee of reliability.

"Hard science" is far from "hard." But economics, by comparison, is essentially a pre-scientific, a priori mode of analysis. That's not to denigrate the valid insights of the likes of Friedrich Hayek and Milton Friedman, but to suggest that the validity of their insights precedes quantification and does not depend on it.

Read on:
About Economic Forecasting
Is Economics a Science?
Economics as Science
Maybe Economics Is a Science
Hemibel Thinking
Physics Envy
Proof That "Smart" Economists Can Be Stupid
Time to Retire the Fair Model
The Thing about Science
What's Wrong with Game Theory
Debunking "Scientific Objectivity"
Science's Anti-Scientific Bent
Ten Commandments of Economics
More Commandments of Economics
Science, Axioms, and Economics
Mathematical Economics