Tuesday 25 October 2016

Don't take it too seriously - economic forecasts are not exact science

Published 29/04/2015 | 02:30

Minister for Finance Michael Noonan speaking at the Spring Economic Statement at Government Buildings
Minister for Finance Michael Noonan speaking at the Spring Economic Statement at Government Buildings

Economist Tim Harford has made a career highlighting where economics is useful and where it fails us. One of the points he makes repeatedly is that forecasting is not an exact science; especially when it comes to big complicated systems like an economy rather than closed systems like a public transport scheme.

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"Economists have allowed themselves to walk into a trap where we say we can forecast, but no serious economist thinks we can," he writes. "You don't expect dentists to be able to forecast how many teeth you'll have when you're 80. You expect them to give good advice and fix problems."

Society has always craved certainty - when there is no such thing. We know forecasts can be wrong, but the question we need to ask is whether the forecasts on which we rely so much are just a comfort blanket or whether they are a dangerous delusion.

At one level, it is clearly absurd for the Department of Finance to begin to predict what will happen to the economy over the next five years. After all, the department missed the last financial crisis - along with almost every other conventional forecasting organisation.

Fast forward to 2015 and we can say that most organisations failed to predict the two biggest reasons why the Irish economy is doing so well right now - low interest rates and low oil prices.

The Department of Finance faces a particular difficulty because political considerations mean it does not even attempt to forecast whether the euro will rise or fall against other currencies; a eurozone government cannot be seen to predict the fall of its own currency.

Yesterday's official forecasts seem sensible enough, but they contain some important caveats.

For example, a table in the report warns a decision by the European Central Bank to raise interest rates by one percentage point could halve growth here. A 1pc contraction in the world economy would knock a percentage point off Irish growth. Taken together, this would be enough to push us close to standstill.

Still, it would be absurd to blame Michael Noonan and his department for trying to predict what will happen.

Good planning demands people make a stab at determining what will happen. We also voted in favour of the Stability and Growth Pact, which mandates governments to generate endless forecasts which must be submitted to Brussels for inspection. Ultimately, the Spring Statement is just an attempt to obey demands imposed by the referendum and Brussels.

People may be reassured that the economic forecasting tools used to draw up the latest predictions have been refined since the crisis to try to capture the dangers posed by the banks and financial sector. We are not using the discredited tools of the past - but the converse of this is that the tools are largely untested and unproven.

The sensible approach to yesterday's statement is to welcome the Government's efforts to issue better and more regular forecasts while not paying too much attention to the forecasts themselves.

After all, most of us have learned to do much the same thing with weather.

Most of us listen to weather forecasts, but still take a look out the window and decide whether to wear a coat based on what we see. We know that a simple forecast for the entire country can't possibly tell us what is happening in Donegal and Waterford.

An economic forecast is no different, and we are doomed to make stupid mistakes if we ever forget this.

Irish Independent

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