Dieter Adam 12 January 2024
Do economic forecasts matter to New Zealand manufacturers? For making investment decisions such as replacing or buying additional machinery, or growing or reducing your workforce, forward customer orders will still be a key determinant. However, many manufacturers will also use information about ‘the general economic climate’ at home and in key markets when making such decisions – even if it’s only ‘in the back of their mind’.
So, how reliable are economic forecasts? While, admittedly, this example shows some of the more serious misses in economic forecasting recently, there is plenty of evidence that economic forecasting isn’t an ‘exact science’. The graphs shown here are a comparison of inflation forecasts made in October 2021 and October 2022, respectively, compared to actual values in November 2022 [1].
Economic forecasting is an old exercise that Thomas Malthus, for example, practiced way back in 1798. A more systematic attempt was made in 1919 with the publication of the Index of General Business Decisions by the Harvard Committee on Economic Research, revised by Warren Persons in 2023[2]. And efforts to improve the accuracy and precision of economic forecasts continue unabated to the present, using ever more sophisticated mathematical and statistical methods and models and, of course these days, AI. The basic idea is that, yes, economic processes are complicated, but so is the weather, and weather forecasting continues to improve. But meteorology is an exact science, dealing with natural phenomena and processes. And at least ever since Herbert A. Simon in 1978 won a Nobel Prize for his work on Behavioural Economics (“for his pioneering research into the decision-making process within economic organizations”), most of us accept that economics is a social science, as the objects of its study are heavily influenced by human behaviour.
One aspect of this is the feedback loop between economic forecasts and economic processes. Weather forecasts change when the weather changes, but the weather doesn’t change as a consequence of weather forecasts (if only …). In economics, however, there is a growing body of research on the impact of economic forecasts on the behaviour of actors in economic processes[3],[4], and many of you will have used information from economic forecasts about development in your key markets to guide investment decisions. Thus, economic forecasts are not as much exact predictions of the future, as they are a tool used by economic actors interactively to co-ordinate behaviour. Actors are likely to respond in a similar way to the same information provided by economic forecasts, thus creating a shared vision of the future that they can use to continuously adjust their decisions. In that way they also reduce the perception of an uncertain future and may contribute to more confidence in making investment decisions.
Another consideration along those lines is how expectations about one’s own future business prospects compare to one’s perspective of the outlook for all businesses. The graph below, taken in December 2023 across all of New Zealand’s businesses, shows that, most of the time, business owners are more pessimistic about their own future than about the economy as a whole. A likely contributing factor will be that business owners have a more acute awareness of the risks for their own business than for the economy as a whole.
[1] https://www.rba.gov.au/publications/smp/2022/nov/box-c-what-explains-recent-inflation-forecast-errors.html
[2] The Review of Economics and Statistics, The Review of Economics and Statistics, Jul., 1923, Vol. 5, No. 3 (Jul., 1923), pp. 187-195
[3] https://www.ncbi.nlm.nih.gov/pmc/articles/PMC5363911/
[4] https://www.sciencedirect.com/science/article/pii/S2405918818301004
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