Why are Economic Forecasts Sometimes Wrong?

Economic forecasts are used to predict how key indicators such as employment, productivity and output will develop over time. Experts then use the information to assess how it will impact the economy.

The question is, why are economic forecasts sometimes wrong, despite analysts having a wealth of information at their fingertips? In reality, on occasion, they are unexpectedly thrown off course by events nobody could have predicted.

While every care is taken to project what will happen several months down the line, in practice, some things are impossible to foresee.

Why is economic forecasting important?

This type of economic analysis is important for both the public and private sectors. Using economic forecasting enables the government to create well-informed monetary, economic and fiscal policies to shape the future of the nation.

An economic forecast includes data such as inflation, interest rates and unemployment figures. It predicts any risks to the stability of the economy and looks at historical data from previous reports to forecast the future.

As well as the government and the Bank of England taking a keen interest, with the aim of avoiding a recession, trade organisations and business owners should also study the reports as they can help them to decide when to invest and what action is needed to grow more profitably.

However, no forecast is infallible, especially when unexpected events occur that throw the analysts off course. The UK economic forecast has been wrong on more than one occasion.

The reason for this can often be pinpointed to an unexpected event, but sometimes, slowly evolving changes can also cause errors. In recent years, Britain's economic forecasts have fluctuated a lot and haven't always played out as initially predicted. We'll take a look at why this is the case.

Unexpected events

Some things happen suddenly and out of the blue, making it almost impossible to predict their impact on the economy. Recent examples include the global Covid-19 pandemic that started early in 2020 and the Russian invasion of Ukraine in February 2022.

The government's Coronavirus: Economic Impact report describes the "magnitude" of the subsequent recession as being "unprecedented in modern times". Britain's Gross Domestic Product declined by 9.7% during 2020 as a result.

This was the steepest drop since 1948, when consistent records first began. Noone could have foreseen how Covid-19 would plunge the whole world into economic chaos when early media reports described just a handful of cases in a remote Chinese market.

Similarly, the war in Ukraine happened fairly suddenly as a result of the Russian invasion. The conflict sparked a huge shock to the global economy, especially to food and energy markets, pushing up prices and causing supply problems.

Both of these events were not predicted and had a disastrous effect on the economy, especially since the conflict began just as the world was trying to recover from the pandemic.

Inflation remains high

Another shock came in May this year, when inflation stayed much the same, despite predictions suggesting it would fall. The Bank of England has been steadily raising interest rates in an effort to bring inflation down and get it under control.

Borrowing costs are now at their highest level since April 2008. Analysts widely predicted inflation would go down significantly in May as a result of the Bank's policy, but this failed to happen.

In April, economists predicted inflation would go down from 10.4% to 9.8% the following month. A survey by Reuters of 39 City economists revealed every one of them expected it to drop. However, this didn't happen, with the reason remaining unclear.

Systematic errors in the economic forecast are often blamed for inaccuracies, meaning small errors in one part of a calculation have had larger knock-on effects overall. This is due to the complex way in which economists calculate their predictions.

The biggest problem in assuring the accuracy of economic forecasts is studying past forecasts and analysing the data correctly, according to economist Stephen K McNees, vice president of Boston's Federal Reserve Bank. He suggests multiple errors can occur during the complex calculations.

Despite the blip in the UK's recovery in May, the International Monetary Fund has predicted it no longer expects the nation to dip into recession later this year.

Andrew Bailey, governor of the Bank of England, has echoed this view, saying that despite the recent "disappointing" figures, he feels inflation has "turned a corner".

Why should businesses study economic forecasts?

Economic forecasting is useful to businesses because it gives them the ability to make informed decisions, developing data-driven strategies for their future success. Using current and historical data enables more accurate predictions for future trends.

Business owners can use this increased visibility to analyse their company as a whole. They can make operational and financial decisions based on current market conditions and future predictions.

However, accurately predicting the future can never be certain. Perhaps due this reason, 30% of Britain's small and medium-sized enterprises have hired an accountant to help them navigate the complexities of running a company.

According to research by Sage, in its Count on Accountants report, nine out of ten businesses in the UK who have hired accountants rate them as an important part of their operation.

While no economic forecast is foolproof, it can provide a useful picture of how the economy is likely to develop, but it's also advisable to have a backup plan in case the unexpected happens.