DAVID M. JONES
Economic policymaking is an art, not a science. It is an art because of the nature of the empirical evidence one has to work with. In a natural science, theorizing can be separated from testing. Scientific tests can be carried out in a controlled environment, precisely measuring the effect of one variable on another, holding other things equal. In economic policy, it cannot. In economic policymaking, forecasting is imperfect. Good judgment and an instinct for good timing are at least as important to economic policymakers as prowess in theoretical model building, technical knowledge, or number-crunching abilities.
This is not to say that one's understanding of the economy, which determines one's forecasts, is not tested. For example, the theories underlying my forecasts are tested daily in the trading room. All too often some poor Treasury bill trader says, "Jones! You told me interest rates were going down last week! They went up! What are you going to say about that?" I say, "Wait a minute! I've got this big theory in economics! In six months I'm sure I'll be right!" The trader says, "Jones! How much money will I lose before you're right?"
It is such interaction of theory and real-world conditions that leads any forecaster away from science and into art. In the trading room, where the real world exists, they are taking into account psychology, technical supply conditions, domestic financial and economic conditions, global conditions, and all the rest. Unquestionably, you want to take all that into account too. And all economic forecasters I know do so.
In order to discuss the art of forecasting, you must first have a good sense of the mechanisms of Fed policy--the process, tools, targets,