The heading of this post is not an invitation for the usual jokes about economic forecasts. It’s clear that most people think forecasting is what economists do, by and large, and that they do it badly. Indeed, some forecasts are a tissue of nonsense – pretty much any UK economcy & trade forecast from Patrick Minford these days for example, although 20 or 30 years ago he was a serious forecaster. I spent a few years myself in the mid/late 1980s doing macro forecasts for the UK and a few other countries, and later, as Economics Editor of the Independent, awarded an annual Golden Guru trophy for the UK forecast of key macro variables closest to the published figures at the time of the award – a necessary qualification because many macroeconomic statistics, especially GDP, are significantly revised over a period of years.

The revisions are with us still, but the techniques of forecasting have greatly improved since then, although of course there is a wide quality range among economic forecasters. For a non-technical guide to economic forecasting, there could be nothing better than Forecasting: An Essential Introduction by Jennifer Castle, Michael Clements and David Hendry. It is a crystal clear and intuitive explanation of what macroeconomic forecasts can and can’t do. It explains the inherent difficulties in trying to forecast the future of a complex non- linear, non-stationary system in which behaviour can be affected by forecasts themselves, all from a limited amount of past data. Better still, it explains the empirical techniques this ace team have devised to tackle some of the challenges.

My only complaint about the book is that the charts are a bit too small for my middle-aged eyesight. Although non-technical, there are lots of charts and it probably won’t make the bestseller list. However, it should be read by any student about to do a time series economietrics course, and to anybody about to start a job as a forecaster. Economics students are proficient in all the relevant software, have ploughed through the statistical theory in their econometrics courses, but anybody starting out as a forecaster naturally lacks the wisdom that comes with the experience of handling the data and seeing your lovingly estimated model produce some dreadful out-of-sample forecasts.

This book represents a treasure trove of crystallised wisdom. It offers up practical insights in clear prose. For example: “This principle of differencing is a method to remove the deterministic components of a forecasting model, by which we mean intercepts and trends. Deterministic terms capture the underlying equilbrium and growth rate of a variable of interest, so are fundamental to modeling, but can be catastrophic for forecasting when either component changes. The differencng principle can be applied to any model with an inherent equilibrium to which it corrects. … But…. if the object needing to be forecast is the level, a good performance forecasting the differences is not necessarily sufficient, as cumulating those differences may lead to an increasing divergence from the level.”

The book ends with some reflections on the limits to forecasting. Some things are inherently unpredictable – including events like the financial crisis which hinged not only on prior macroeconomic trends able to be captured in a macroeconometric model but also on unexpected policy decisions like letting Lehman Brothers go bust. But  the book notes that the forecasting process is not just about numbers but also about the narrative, at least in any macro policy context. Hendry coined the term ‘forediction’ to capture this.

No doubt the public at large will continue to mock economists and their forecasts, but they will always be needed, and in that case should be as good as economists can make them.

Forecasting: An Essential Introduction

Jesse Norman is one of the most thoughtful of the UK’s MPs, a principled Conservative, and has followed up his earlier biography of his hero Edmund Burke with Adam Smith: What He Thought and Why It Matters. It’s an excellent overview of Smith’s life and work. It would make a terrific read for economics students but also has much to interest those who’ve read every book about Adam Smith going. Like many recent books about Adam Smith (such as Emma Rothschild’s Economic Sentiments and Nicholas Phillipson’s biography An Enlightened Life), it reclaims the Theory of Moral Sentiments as having equal importance to The Wealth of Nations.

Part of Jesse Norman’s aim is to dissociate Smith from the ‘free market’, invisible hand caricature of many conservative economists and thinkers. The first part of the book is a pretty standard biography, nicely done. The second part is a history of how neoclassical economics came to hijack Adam Smith, stripping away from his thinking much of its richness and depth, not only in terms of human behaviour (not narrowly self-interested in Smith) but also in terms of institutional context (dynamic, contingent, evolutionary). The book has a nice section on Vernon Smith, whose experimental work in the 1980s was an early critique of the assumptions of neoclassical general equilibrium theory. In effect, it argues, much of modern neoclassical economics as it peaked in the late 20th century was foreign to Smith’s approach. What Smith did do was: “Set out the field of political economy with markets at its centre,” but in a way that makes institutions and historical sensibility equally central.

(There is also a section on Smith’s strong, principled opposition to the slave trade. It can never be said often enough that economics got the label ‘the dismal science’ from Carlyle because economists were prominent campaigners against slavery.)The book ends with a section on ‘why it matters’ and what a Smithian perspective would be on the economy now. Norman notes the tyranny of the arid mainstream perspective in policy economics right up to the financial crisis (although academic economics had by then already started to move decisively away from free marketism): “What is so striking about that crisis in retrospect is not, even, the egregious self-enrichment of the previous decade, or the specific failures of policy, law and enforcement involved. It is the intellectual grip which the language of free markets held on almost all the parties concerned, regardless of the often very different reality.” Indeed, free marketism still has a strong grip on policy, given that so many policymakers were trained in their economics when it was still at its peak.

What is to be done about this. “We need a new master narrative for our times,” Norman writes (italics his). The book calls for political renewal too. Who could disagree? (Although that makes it disappointing that Jesse Norman declared himself a supporter of Mr Johnson in the current Conservative leadership campaign.) It concludes, of course, that returning to the true Adam Smith can help shape the new narrative with markets still central to economic life but understood in the context of a political economy in which institutions, historical context and human nature play their proper role.