Why economists can’t predict the future

20 October, 2017 at 17:50 | Posted in Economics | 2 Comments

 

Economic predictions and forecasts have little value. They usually amount to nothing more than intelligent guessing.

Making forecasts and predictions obviously isn’t a trivial or costless activity, so why then go on with it?

The problems that economists encounter when trying to predict the future really underlines how important it is for social sciences to incorporate Keynes’s far-reaching and incisive analysis of induction and evidential weight in his seminal A Treatise on Probability (1921).

treatprobAccording to Keynes we live in a world permeated by unmeasurable uncertainty – not quantifiable stochastic risk – which often forces us to make decisions based on anything but ‘rational expectations.’ Keynes rather thinks that we base our expectations on the confidence or ‘weight’ we put on different events and alternatives. To Keynes, ​expectations are a question of weighing probabilities by ‘degrees of belief,’ beliefs that often have preciously little to do with the kind of stochastic probabilistic calculations made by the rational agents as modelled by ‘modern’ social sciences. And often we “simply do not know.”

How strange that social scientists and mainstream economists, as a rule, do not even touch upon these aspects of scientific methodology that seems to be so fundamental and important for anyone trying to understand how we learn and orient ourselves in an uncertain world. An educated guess on why this is a fact would be that Keynes concepts are not possible to squeeze into a single calculable numerical ‘probability.’ In the quest for measurable quantities, one puts a blind eye to qualities and looks the other way.

So why do companies, governments, and central banks, continue with this more or less expensive, but obviously worthless, activity?

A part of the answer concerns ideology and apologetics. Forecasting is a non-negligible part of the labour market for (mainstream) economists, and so, of course, those in the business do not want to admit that they are occupied with worthless things (not to mention how hard it would be to sell the product with that kind of frank truthfulness). Governments, the finance sector and (central) banks also want to give the impression to customers and voters that they, so to say, have the situation under control (telling people that next years x will be 3.048 % makes wonders in that respect). Why else would anyone want to pay them or vote for them? These are sure not glamorous aspects of economics as a science, but as a scientist, it would be unforgivably dishonest to pretend that economics doesn’t also perform an ideological function in society.

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2 Comments

  1. “why do companies, governments, and central banks, continue with this more or less expensive, but obviously worthless, activity?”

    My guess is that quants take complete sections of the market and simulate all possible future states at time t+1 and use linear algebra optimization to select the portfolio that at least meets a minimum payout vector. There is a MOOC, Financial Analysis and Risk Management, that explains how to do it. I’m still trying to figure it out.

    The answer to your question is, companies do it for profit. They may have found a mathematical way to impose their model on asset markets and profit. They can use rational self-interest as their motivation, and leverage mathematics to derive a riskless profit from asset markets. The math they use may or may not need rational expectation assumptions. As mentioned, if you can simulate every possible future market state and derive a portfolio that still profits (perhaps you buy insurance against a state where all stocks crash at once), you don’t have to have explicit rational expectations, or even probability, in the linear algebra equations.

    There is of course the sales advantage, the pretension to knowledge, that you mention.

  2. In place of an astrologer’s prophecy of the future, it would be useful if economists could say something truthful about the consequences of the present.


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