Ignore the IMF: Economic forecasts have a history of being unreliable

So the IMF has slashed its growth forecasts for the UK economy.  This august body has just pronounced that Britain’s economy will come to a virtual standstill.  Growth in 2012 will be just 0.2pc, compared with the IMF’s April forecast of 0.8pc growth.  It cut its 2013 growth forecast by the same margin to 1.4pc from 2pc.  Britain’s growth downgrade for 2012 is the largest of any country in the developed world.

Basically, am I bovvered?  More importantly, should anyone else be?  Let’s look at the track record.

The last major economic crisis was the East Asian one in 1998, when the previously booming economies experienced spectacular falls in output.  But where was the IMF in this?  In May of 1997, the IMF predicted for 1998 a continuation of the enormous growth rates which those economies had experienced for a number of years:  7pc growth was projected for Thailand in 1998, 7.5pc for Indonesia and 8pc for Malaysia.  Yet the actual outturns for 1998 for these countries were spectacularly worse, with output not growing but falling by large amounts. The fall in real GDP in 1998 was –10pc in Thailand, and –7pc and –13pc in Malaysia and Indonesia, respectively.

Think back to 2008.  In January that year, according to the consensus forecasts, it was going to be business as usual in 2009.  A steady 2pc growth in both the UK and the Eurozone, and 2.7pc in the US.  In fact, as we now know, there was the worst collapse in output since the Great Depression of the 1930s.  GDP fell by 4pc in the UK, 4.3pc in the EU and 3.5pc in America.

The forecasts were, admittedly, revised down as the year went on.  But as late as August 2008, just a few weeks before the collapse of Lehman Brothers, positive growth of GDP was still being predicted for 2009.

Even more incredibly, by then the UK economy was already in recession.  Output had started to fall in the April-June quarter of that year.  And the same sharp falls began in America.

Things haven’t really got any better than when the American econometrician Lawrence Klein published the first forecasts of the US economy in 1945.  Klein was eventually awarded the Nobel Prize for his work in this area.  He predicted that in 1946, unemployment in America would be 8 million.  It turned out to be 3 million.

The lesson of all this is that economic forecasts need to be taken not just with the proverbial pinch, but with the entire contents of a Siberian salt mine.  Yes, people like to have them, and need to form a view about the future.  But they are at their worst exactly when an accurate forecast would be most useful.  At turning points, when the economy is going into a recession or a boom.

by Paul Ormerod.

This article was featured in CityAM on 18th July

1 Comment
  1. The big question is whhteer this downturn will behave like the other post WWII recessions, or like the great depression. So far, most predictions that it would behave normally (starting from a year ago) has been obliterated although much of this is because the government response has been pathetically below expectations (until, perhaps, the last month).Immediate history, therefore, may not be a good prediction. We can note some unique factors:The average lifespan of autos, for instance, has increased, but up through 2006 we continued to exhibit sales growth outpacing population growth. This suggests excess ownership, which can be redistributed through second-hand sales (particularly as people lose jobs). In other words, leaving aside super-deals (and we’ve seen some of them), what is the natural resupply rate for the US auto market? I suspect that, under pressure, consumers could keep their clunkers going quite a while. As new data has come in, the US auto industry has continued to cut production and push back the anticipated date of its demand-rebound, and it may just settle down to a lower steady-state (not necessarily a bad thing). And this is not just a US problem. Sales of importers to the US have suffered almost as much.We can ask the same question of cell-phones and computers. Prior to the meltdown, sales were kept up partially be replacement (upgrading monitors to flat screens) to newer models, and partly by purchases of second and third systems (discretionary). So where are the new systems that are crucial to have, and will people sustain discretionary purchases? (Is there another big leap in the next year, or are we running-out the product lifecycle?) Likewise, homeownership has exceeded historical levels, and we still have an excess supply due to second-home ownership and investment ownership. Also, if we see a long term transition to smaller (but more efficient/comfortable) homes, there is no reason for larger and poorly constructed homes to reflate in value (leaving consumers chained to long-term debt payments).Also, there’s the question remains just how much real and longlasting change has occurred to the consumerist American psyche. We won’t know that for a while, but many semi-discretionary purchases (clothing, accessories, electronics, travel) could continue to suffer as some people re-evaluate their entire lifestyle.Remember, that in spite of the highly-criticized aggressive US Fed action, we just saw 0.4% year-on-year decline in prices. In the long run, there are sectors that need to grow but something needs to keep demand stable/growing long enough for resources to transition into the new sectors (and those new sectors may require significant govt. support).There is still concern that govt. is not doing enough and that the periodic upward blips (with bear market rallies) will keep giving everyone hope that the economy will heal by itself in just a few months (without taking the aggressive steps necessary).

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