Models Behaving Badly

LONDON – “Why did no one see the crisis coming?” Queen Elizabeth II asked economists during a visit to the London School of Economics at the end of 2008. Four years later, the repeated failure of economic forecasters to predict the depth and duration of the slump would have elicited a similar question from the queen: Why the overestimate of recovery?

Consider the facts. In its 2011 forecast, the International Monetary Fund predicted that the European economy would grow by 2.1% in 2012. In fact, it looks certain to shrink this year by 0.2%. In the United Kingdom, the 2010 forecast of the Office for Budget Responsibility (OBR) projected 2.6% growth in 2011 and 2.8% growth in 2012; in fact, the UK economy grew by 0.9% in 2011 and will flat-line in 2012. The OECD’s latest forecast for eurozone GDP in 2012 is 2.3% lower than its projection in 2010.

Likewise, the IMF now predicts that the European economy will be 7.8% smaller in 2015 than it thought just two years ago. Some forecasters are more pessimistic than others (the OBR has a particularly sunny disposition), but no one, it seems, has been pessimistic enough.

Economic forecasting is necessarily imprecise: too many things happen for forecasters to be able to foresee all of them. So judgment calls and best guesses are an inevitable part of “scientific” economic forecasts.