How valuable are economic forecasts?

Lao Tzu, the 6th century Chinese poet, wrote, “Those who have knowledge don’t predict. Those who predict don’t have knowledge.”

The financial services industry hasn’t paid him any heed. We’ve been deluged with the annual economic and market forecasts that traditionally mark the turn of a new year. Is it worth paying attention to these forecasts? Or are they a waste of time? Maybe a little bit of both?

“Marketplace Morning Report” host David Brancaccio spoke with Marketplace senior economics contributor, Chris Farrell, to assess their worth. The following is an edited transcript of their conversation.

David Brancaccio: We know that longer-view economic financial market forecasts are not particularly accurate. And I think I’m being charitable by “not particularly accurate,” right?

Chris Farrell: Right. You're being very charitable, because the track record — it’s famously poor. Let's take recessions. And recessions aren't rare. Economies are in recession about 10-12% of the time. And what is rare is accurate forecasting of the turn to recession. So, there's this IMF study, and it looked at private and public forecasts of recessions in 63 countries over a 22-year period, and the average forecast predicted inflation-adjusted growth a 3% a year before the recession. Now another study, it tracked financial gurus in their year-ahead price targets for the S&P 500. Now this would matter, right? Their accuracy rate, on average, was roughly 47%, which statistically, is worse than a coin flip.

Brancaccio: My thing has long been when an analyst gets something right, they brag. They answer media phone calls to brag more. When they get it wrong, guess who doesn't return the phone calls and own up? But in fairness, the news never stops, and a static forecast is out of date the moment the forecaster hits send, right?

Farrell: Economic data, it's messy. It gets revised over time, and we don't have good data about so many vital aspects of economic activity either. And then, more fundamentally still, you can't get rid of the uncertainty when guesstimating the future. I mean, major shifts in economies and financial markets, they often reflect the impact of outlier events.

Brancaccio: I mean, do we get anything out of these forecasts, given the track record?

Farrell: I think so. And Michael McCracken, he's a senior economist at the Federal Reserve Bank of St Louis, and he makes a sober case for the value in forecasts in a recent interview. Good forecasters these days typically offer a range of possible outcomes, so they're trying to take that uncertainty into account. Forecasts aren't perfect, because life is uncertain. But the reason why everyone from central bankers to small business owners to everyday households makes forecasts is that the activity offers insights for planning ahead. So, instead of dismissing data-driven forecasts, treat them as one input into a broader planning exercise.

Brancaccio: I remember being at the launch of an official forecast. I was all waiting to hear where the economy was going, and the forecasters came out and said, “Well, one of our forecasts is that the economy gets better. Another one of our forecasts is that it's flat, and another one is that it gets worse.” And so, that seems ridiculous at first, but then you realize companies have to think that way too. You got to plan for all three in the end.

Farrell: In the end, you do because you make your bets, but then you also hedge in case that bet goes wrong.