Are Economic Forecasts Reliable?

Nate Silver writes:

Growth rates during an election year are a good but imperfect indicator of electoral performance. The two times that economic activity actually shrank during an election year, 1980 and 2008, the incumbent party lost badly. The two times that it grew by more than 6 percent, 1944 and 1972, it won overwhelmingly. But Eisenhower won a landslide in 1956 despite tepid 1.8 percent growth, and George W. Bush won in 2004 with only 2.9 percent. The economy grew about 5 percent in 1968, but that wasn’t enough to save Humphrey.

Some political scientists have tried to explain these exceptions by resorting to an alphabet soup of economic indicators, conjuring obscure variables like R.D.P.I.P.C. (real disposable-personal-income per capita), which they claim can predict elections with remarkable accuracy. From the standpoint of responsible forecasting, this is a mistake. The government tracks literally 39,000 economic indicators each year. Although many (say, privately owned housing starts in Alabama) are obscure or redundant, perhaps two or three dozen of them are looked at regularly by economists.

When you have this much data to sort through but only 17 elections since 1944 to test them upon, some indicators will perform superficially better based on chance alone, the statistical equivalent of the lucky monkey from a group of millions who banged out a few Shakespearean phrases on his typewriter. Conversely, indicators like the unemployment rate have historically had almost no correlation with election results despite their self-evident importance. The advantage of looking at G.D.P. is that it represents the broadest overall evaluation of economic activity in the United States.

There is, however, another problem: economic forecasts are not very good. In fact, they are completely terrible. In November 1995, economists expected the economy to grow at 2.6 percent the next year; it actually zoomed upward by 4.4 percent. In November 2007, they expected it to grow at 2.5 percent, but it shrank by 3.3 percent, as the effects of the global financial crisis became manifest. Frighteningly enough, the margin of error on an economic forecast made a year in advance is about plus or minus 4 percent of G.D.P. Advance forecasts of election results must account for this uncertainty, either by expanding their own margins of error to accommodate it or by making their predictions conditional upon different economic situations.

Yet we still listen.

Source.

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