Think of a Number: A Theory of Rational Forecasting
De Jasay, Anthony, Freeman
Recently, an economist gained notoriety and filled his appointment diary with lucrative conferences by having some of his forecasts for U.S. economic data, made two years ago and look- ing quite eccentric at the time, come gloriously true. This random event inspires me to put forward the sketch of a theory of rational forecasting.
Suppose that 500 of the most distinguished academic, industry, and Wall Street economists are polled for their best guess of the U.S. unemployment rate and the Dow Jones Industrial Average 12 months from now. As each has a reputation to preserve, none will stick his neck out with an outlandish forecast that has but a tiny probability of coming out right - even though it would earn him a jackpot if it did. Therefore, the forecasts of the 500 will cluster in a narrow range of, say, 7-11 percent for the unemployment rate and between 7500 and 9500 for the Dow.
What is left for the 250,000 other, less-distinguished economists to do to gain fame and fortune? They too can offer forecasts and might put them on some record. If they place them in the cluster and the actual out- come is in the cluster, they remain unremarked and neither gain nor lose anything. If they go way outside the cluster and the outcome is in the cluster, nobody will remember the wrong forecast made a year earlier. They will again gain nothing and lose nothing. If their forecast is in the cluster and the actual outcome is way outside it, they will be in the good company of their 500 more-distinguished fellows and will again remain unremarked.
There is, therefore, a single rational forecasting mode for our undistinguished economist to adopt. Let him think of a number for the unemployment rate and one for the Dow Jones index - say 23 percent and 4000, respec- tively. He can easily draft a scenario for the next 12 months full of horrors and glitches that would make the forecast numbers plausible. The probability that either one of his numbers will turn out right is very small and that both will turn out right is even smaller. …