Michael Mussa on the art of economic forecasting

Michael Mussa of Peterson Institute,  is responsible for presenting economic forecasts from the institute. He was earlier at IMF as its chief economist. His forecast come earlier than IMF’s World Economic Outlook forecasts and is a source of irritation for its former employer. He recently presented his world economy forecast on April 8,2010 (two weeks before IMF’s forecast on 21 April 2010).

In 2009, Mussa took a different view than most forecasters. He said world economy would recover sharply and it would be a V-shaped recovery. People laughed him off but his forecast has been kind of true. The pace of recovery has surprised all.

In a recent interview, he explains art of economic forecasting.

Steve Weisman: For nearly three decades, Michael Mussa, senior fellow at the Peterson Institute for International Economics, has been doing economic forecasts—first at the University of Chicago and later at the IMF, now here at the Institute. He’s been wrong, he’s been right. Right now, his forecast looks pretty good. This is Steve Weisman at the Peterson Institute, here to talk with Mike about his current forecast but more generally about the art of forecasting and how one goes about it. So, Mike, thanks for joining me.

Michael Mussa: My pleasure.

Steve Weisman: Let’s talk about what an economic forecast is and is it an art or a science?

Michael Mussa: In any economic forecast, you’re seeking to project how the economy will perform over the relatively near-term future, usually out a year or two. And we generally refer to longer-term forecast as projections and there, it’s mainly assessing what the likely longterm trends of the economy are, which is a somewhat different game than near-term forecasting.

Steve Weisman: Sort of like weather versus climate?

Michael Mussa: Yes, in many respects indeed.

He discusses why he forecasted higher growth in 2009

Steve Weisman: Last year at the depth of the recession, you predicted that the recovery would be more brisk than many others did. And it looks like your predictions turned out to be more correct. Isn’t that right?

Michael Mussa: Yes. Generally over the years, my forecasts have not been very different from the consensus, the average view of most other forecasters. Last year, I took a decidedly different view, being at or even a little above the upper end of forecasts by say, the bluechip panel of 50 forecasters for the United States or the Economist panel or others, because I sensed a little more than a year ago that probably the government had done enough to bring an end to the financial crisis and that we should anticipate an economic recovery beginning around the middle of 2009. The rule in recoveries is they surprise you on the upside.

Steve Weisman: But if something continuously surprises you, why is that surprising?

Michael Mussa: It’s an oddity about forecasting that in the upturn, forecasts turn out to be too low. Partly that may be that you don’t know exactly when an upturn is going to start and whether it  will be sustained or may poop out after a quarter or so. But I think another element of it is, for private forecasters, that you’ve almost always missed forecasting a recession and you don’t want to make another mistake in the same direction. So the tendency is to be quite cautious about forecasting the upside recovery. I take a different view. I said, well, I missed the recession, I’m not going to miss the recovery.

Steve Weisman: Why are forecasts so different? Do some people look at some things as opposed to others? And if so, what’s your particular approach?

Michael Mussa: It’s just part of the art and the science of the exercise. The fact of the matter is that the future course of the economy is uncertain and there’s no way that one can predict with a high degree of accuracy how things are going to transpire. And especially in circumstances such as you’ve had over the past year where there’s a question about whether we were going to get a recovery and then how strong it might be. The degree of uncertainty is large and naturally the range of forecasts, which tend to be centers of distributions of what people think the most likely outcomes will be, also are more dispersed than normal.

Some basics about economy and financial market linkages

Steve Weisman: Last year, I know a lot of people said that this is going to be a slower recovery because of the weakness of financial institutions. And that was a fundamental premise that you didn’t quite accept. So it wasn’t just like choosing this indicator versus that, it seemed to be almost more of a kind of basic analytical difference of view that you had.

Michael Mussa: There was some difference of analysis. My reading of the historical record is that it is the recovery of the economy that ultimately rescues the financial system. It’s not the restructuring of the financial system that produces the economic recovery. And I think we’re seeing again a repeat of that now. Bank profits are going up, their valuations in the stock market are going up, and that’s primarily because the economy is stronger, loan losses are [declining] or [are] expected to decline. And I anticipate that in a recovery we would see that, as we have in most past recoveries. And there was too much emphasis in other people’s forecasts about how dire this situation would be in financial institutions, especially if we got what they were predicting, which was virtually no recovery.

Steve Weisman: So what do you see now given that these institutions are strengthening?

Michael Mussa: I continue to expect what I regard as a moderate-paced recovery. So I’m projecting in the first six quarters of recovery, which ends at the end of this year, that we’ll get between 6 percent and 7 percent cumulative growth. So it’ll be growing at about a 4-percent rate annually, and at that pace of advance we’ll continue through next year. Now, that’s well below the average pace of recovery following deep recessions earlier in the post-war period. So a lot of the arguments that we should expect a slower recovery this time, I assign credit to. I just don’t want to give too much credit to them.

He also talks about political economy of forecasting

Steve Weisman: Let me ask you about the political context of economic forecasting. What’s the history of administrations distorting forecasts in order to further their political goals? You’ve been in the US government; you served on the Council of Economic Advisers. How credible is any administration on this?

Michael Mussa: Doubts are always expressed, are often expressed that the forecast has some political element in it. I think that there’s some element of truth in that. But the other side, I think we’ve seen recently that when it came in, the new administration had an initial forecast for the economy that was very similar to the average of private forecasts at that time. But it turned out that the unemployment rate did not peak at around 8 percent or a little higher. It went on up to 10 percent. So they persistently got slammed in terms not only of the forecast but in saying that their stimulus package was a failure  and all the rest of it because the outcome turned out to be worse than they were projecting. That, I think, tends, if anything, to make them a little bit gun shy about forecasting a relatively strong recovery—because if they’re right, they’re not going to get much credit for it and  if they’re wrong, then they’re going to get a lot of blame. So one thing, if it’s a normal bias perhaps to overstate things on the optimistic side, there’s an important deterrent to doing that now.

Hmm.

I don’t know but am always suspicious to this economic forecasting business. On forecasting, I always recall this Bernanke speech:

The only economic forecast in which I have complete confidence is that the economy will not evolve along the precise path implied by our projections.  Nevertheless, as I have already noted, because policy affects spending and inflation with a lag, Committee members have no choice other than to make medium-term forecasts–provisional and subject to uncertainty though they may be.

I was just reviewing this blog’s previous posts on forecasting and was surprised to see quite a few posts. In case you are interested, see these previous posts.

One Response to “Michael Mussa on the art of economic forecasting”

  1. Morre Michael Mussa « De Gustibus Non Est Disputandum Says:

    […] sobre Michael Mussa aqui e aqui. Share this:FacebookPrintTwitterGostar disso:GostoSeja o primeiro a gostar disso post. […]

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