Are the New Year’s economic predictions really worth reading?

You won’t be surprised that the answer coming from an economist is unsurprisingly “yes”, although I recommend choosing the right pair of glasses. This traditional beginning-of-the-year exercise encourages economists to be extremely modest. As they prepare their new economic forecasts, economists inevitably reread last year’s predictions, and the experience of confronting them with reality is sometimes sobering.

Like many forecasters, we predicted that Eurozone growth would moderate in 2017 due to growing political uncertainty and the waning of the positive impact of the previous years’ low oil prices. As it turns out, however, growth accelerated buoyantly in the eurozone countries after several surprises, both favourable (notably the sharp decline in political uncertainty) and unfavourable (a stronger euro and the absence of a US fiscal stimulus). Several developments were also in line with our scenario (higher energy price inflation; the ECB’s maintenance of an expansionist policy). The dominant factor – and the hardest to pin down – was psychological. In 2017, companies and households both became convinced that the conditions for a sustainable recovery had finally come together. This triggered a virtuous circle, in which self-sustaining growth fuels even more growth.

Several lessons can be drawn from this when reading articles with the predictions for 2018:

1. Though often criticised, the consensus is useful because it indicates the general direction of the trend (faster or growth);
2. Although low dispersion between individual forecasts is reassuring, we should be wary of an overly broad consensus: complacent optimism risks triggering even greater disappointment when bad news breaks;
3. It is important to evaluate the sensitivity to a given growth scenario: if slightly weaker or stronger growth doesn’t make much of a difference for the decisions which you need to take, it is better to concentrate on more extreme scenarios, their potential impact, what could trigger them and what is the likelihood
4. The arguments used to support a scenario are even more important than the growth forecasts themselves: we should try to determine whether a given scenario is based on one or several factors (the first case would be slightly discomforting, the second more reassuring), and whether the most relevant factors have been taken into account;
5. Alongside objective factors like income, profits and interest rates, economic developments are derived from human behaviour, and are thus highly dependent on psychological factors. 2017 was a perfect illustration of this point. When indicators are looking as upbeat as they are today, it is worth being cautious and asking what could possibly cut short the prevailing optimism. In addition to exogenous shocks, a key factor might be an economic reality that no longer matches elevated expectations: negative surprises are an obvious factor which can weigh on confidence. It is for this reason that I look towards the year 2018 with confidence whilst being vigilant