The Great Financial Crisis was a watershed moment for Economics.  The failure of the profession to forecast the crisis and its subsequent overly optimistic forecasts about how the economy would recover revealed PhD Economists are no better at forecasting the future than Astrologers.

This inability to make accurate forecasts is very important.

The argument for leaving monetary policy in the hands of the PhD Economists is they are technocratic experts who can accurately forecast the economy and take action to improve the performance of the economy based on these forecasts.  But it doesn’t make any sense to rely on these PhD Economists if they cannot accurately forecast the economy or the impact of their policies on the economy.

I am not the only person pointing out forecasting failures lead to a loss in credibility.  According to Bank America Merrill Lynch,

The Bank of England’s forecasts are losing authority with the public as well as markets.

This loss of credibility has been richly deserved as the forecasts have been consistently wrong.

It’s no secret that economists are terrible at predicting recessions: a host of studies, along with a raft of anecdotal evidence, reveals a track record that is astonishingly bad….

Prakash Loungani and his colleagues at the International Monetary Fund conducted the most sophisticated studies of economic forecasting, assessing the accuracy of economists in 63 countries between the years of 1992 and 2014. The results, as my colleagues at Bloomberg have noted (see here and here) are mind-blowingly awful. In fact, every single country displayed the exact same bad track record of predicting recessions. Moreover, as Loungani and his co-authors noted, “the forecasts of the private sector and public sector are virtually identical; thus, both are equally good at missing recessions.”

Not only have their forecasts been wrong, but the PhD Economists’ belief in these forecasts has justified the pursuit of policies since 2008 that have had toxic side effects.  These side effects include growth in inequality and undermining trust in experts.

Rather than get into the excuses the PhD Economists offer for this pathetic track record, let me say it isn’t just the techniques Economists use to forecast that account for their dismal forecasting record.  Based on the response to the Great Financial Crisis, it is safe to say Economists are not experts.

At the time, they had zero knowledge about the design of the financial system and how it should have been used to protect the real economy from the poor lending decisions by banks and investors.  No place was this better demonstrated than by the fact their main forecasting models specifically excluded the financial system.

Much more distressing is over a decade later and the PhD Economists are still equally clueless when they talk about the financial system.

This is truly remarkable as I can explain the design of the financial system to a 6-year old using a clear plastic and a brown paper bag.  If a 6-year old can understand the design, surely these self-proclaimed experts ought to be able to understand.  [Although with PhD Economists I cannot discount Upton Sinclair’s observation about no one being so blind as a man whose job depends upon his not seeing.  However, if this is true, it is all the more reason to exclude them from any involvement in policymaking roles.]

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I have heard a number of different excuses for Economists inability to make accurate forecasts.  My favorite excuse was the idea market participants react to economic forecasts and this accounts for the dismal track record.  As I understand this excuse, Economists make a forecast.  Market participants then adjust their behavior based on this forecast.  Hence, the market participants reaction effects where the economy is as a result of the forecast.

At first, this sounds so good.  But a nanosecond later, the problem with this excuse appears.

Imagine the forecast is for a recession.  Market participants should react by taking actions to protect themselves from the recession.  This reaction should in fact result in a recession.

All good except for one small detail.  Market participants know central banks have this forecast of a recession.  Market participants also know central banks will adjust their monetary policy to head off the recession.  Hence, market participants won’t take any steps to protect themselves as they know the predicted recession won’t occur.

So if Economists were really good at predicting recession, no recession should ever occur.  Clearly, that is not the case.