Economists must acknowledge the limits of their knowledge

Engner cites this story as an example that highlights the general overconfidence that prevails among economists in forecasts and what they are in a position to deliver. As he writes: “Given all the work on overconfidence, its causes and consequences, you might think that economists would be the epitome of humility. You will be shocked to learn that they are not.”

My favorite example when it comes to economists’ overconfidence is the fact that they estimate gross domestic product (GDP) growth down to the decimal point. GDP measures the economic size of a country and the growth of GDP is the increase in its economic size after adjusting the figures for inflation. How can one make such specific predictions about something as complex as our economy, down to one decimal point?

Let us consider the Professional Forecasters Survey of the Reserve Bank of India. In this survey, the Indian central bank surveys economists on several economic parameters such as GDP growth, inflation, private consumption growth, etc. Let us consider the period from 1st April 2018 to 31st March 2019. The reason to consider this year is simple. There is no way that any economist can forecast the Covid pandemic in advance and build its impact into the forecast.

In the forecast of 7 June 2017, the average GDP growth for the financial year 2018–19 was estimated at 7.8%. As of April 4, 2019, when the final forecast for the period was made, average GDP growth was estimated at 7%. Real GDP growth for 2018-19 was 6.5%.

In fact, a trend that can be clearly seen in the RBI’s business forecast survey is that the closer we come to the period for which the forecast is being made, the closer the forecast is to the actual growth figure, with Together we end. This is hardly surprising, given that the closer we get, the more access we have to real-time economic data, which gives a better understanding of the real economic landscape and, in turn, helps to get closer to forecasting. does. up to actual growth figures

For 2018-19, economists started with a forecast of 7.8% and eventually reduced it to 7%. Still, they were wrong, but at least close to the actual increase of 6.5%.

Now let us consider the private consumption growth for the period October to December 2022. In the forecast for 10 February 2022, average private consumption growth was expected to be 5.8%. Till 8 February 2023, it was revised to 4.3%. Real consumption growth came in at 2.1%.

In fact, a median forecast hides a wide variation. The highest growth in private consumption forecasts was 8.8%. At the other end of the spectrum, private consumption was projected to decrease by 0.60%. The point is that many economists got their personal forecasts wrong. This is also not surprising, given that the Indian economy is large, complex and influenced by a myriad of economic factors for which numbers are not always available. Therefore, in order to be able to make predictions, assumptions need to be made.

In this scenario, one way to operate is to estimate a range rather than a specific figure right down to the decimal point. The range may be wide enough to start with and gradually narrow as we approach the period for which the forecast is made.

In fact, economic survey It does so for 2022-23 while estimating India’s GDP growth for 2023-24.

The survey projected a GDP growth of 6.5% with a disclaimer that “the actual outcome of actual GDP growth will probably be in the range of 6% to 6.8%”. This is the right way to go about things.

Of course, in some cases, the government has to make specific forecasts to prepare the budget numbers.

One must ask why economists have been making such specific forecasts over the years. The simple answer is that they are probably just following tradition. Since that’s the way things have always been, why worry about changing?

Also, economists are encouraged to do so. In the financial and economic world, confidence is commonly mistaken for competence. As Eric Enger says: “Part of the story is that confidence can be confused for competence.”

In such a scenario, any economist who works for a corporate, a stock brokerage, a mutual fund, a think-tank, or a rating agency, and decides to make granular forecasts in a certain range, is called someone can be considered as such. Who is not believing his words. And this is the worst thing that can happen to any specialist. Therefore, reliable forecasting needs to be done right below the decimal point.

But the fact is that these GDP forecasts, like others, eventually get revised. So, in general, it makes sense for economists to be more modest and less confident than usual about their economic forecasts.

Vivek Kaul is the author of ‘Bad Money’