Economic Forecasts: Too Smooth by Far? by Prakash Loungani and Jair Rodriguez, International Monetary Fund
June 1, 2008
Prakash Loungani and Jair Rodriguez
International Monetary Fund
Vol. 9, No. 2, April-June 2008
Two questions about the global economic outlook are a matter of active conjecture at the moment:
• First, will the U.S. economy go into a recession?
• Second, to what extent will the rest of the world be affected by developments in the U.S. economy? In the parlance of the day, will countries "decouple" from the United States?
To those turning to private sector economic forecasters for guidance on these questions, this article sounds a note of caution: the past performance of forecasters on these two questions leaves much to be desired. Few recessions have been forecast ahead of their arrival. Nor do forecasters take into account fully the dependence of economies on one another; we present evidence that the dependence on the U.S. economy of the other members of the G7 has been under-appreciated by forecasters in the past. In short, economies are coupled, but one country's forecasters often seem to be decoupled from those in other countries.
Why isn't the performance of economic forecasters better? There can be many reasons, but the one emphasized here is forecasters' excessive caution. Forecasts ought to be revised early and often so as to absorb new information promptly. But the evidence presented in this article suggests that forecasters take very long to reflect information in their forecasts. As a consequence, revisions to forecasts tend to be smooth.