Friday, October 06, 2006

If I had a nickel for every time... 

Gary reads the latest report of the always-shrinking deficit and asks the eternal question:
Indulge me as I vent on a pet peeve of mine: How do these forecasters stay employed if they�re seemingly always underforecasting revenues? If I had a dollar for each time I read the term �better-than-expected� in articles about the various economic reports, I�d be rich and then some.
Well indulge me as a vent on a pet peeve of mine -- that forecasters are always misunderstood. I speak as one of the forecasters. People who stand outside the forecasting millieu and carp about budget forecasts are missing the many slips twixt the cup and the lip of budget forecasting. There needs to be not only a forecast of the economy and of the relationship between the growth of the economy and growth of the various bases on which tax is paid, but also a forecast of changes in future spending and taxes perpetrated by capricious legislators. Moreover, firms who engage in rent-seeking behavior are making investments in anticipation of tax and spending changes, and some of these investments become resource-wasting when the investors' expectations are not realized. And part of the problem is that revenues have become much more volatile since 1990.

"And still you forecast," you say, dear reader. "Why?" Because decisionmakers need a context for their decisions, and forecasts are meant to provide that, and so I make a few dollars. When you are forecasting, you make mistakes almost every time. You aren't trying to minimize the error so much as you are trying to minimize the cost of the expected error to the decisionmaker. If you are forecasting a budget deficit for the legislature or the executive of any government, the costs of underestimating and overestimating are different, not symmetric. If I forecast a larger deficit than what happens, I have restricted spending and led to a rather pleasant surprise to the government. The additional spending not done is bad for those who would have received the benefits, but good for everyone else because national savings is higher and interest rates thus lower. The good will make the morning paper; the forgotten If I underestimate the deficit, the costs on everyone from higher interest rates is noticed, and the rising deficit is a cudgel brought down on politicians. Since the politician is my client, I'm incented to prefer overestimating budget deficits to underestimating.


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