Where is the world economy headed?

Fri, 20 Aug Pre-Open

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That may very well be one of the most often asked questions in the business world. After all who wouldn't want to know the answer to that question? Decisions worth trillions and trillions of dollars are at stake. Whether to invest on capacity expansion or to cut back on it. Whether to recruit more employees, or to fire a few that you already have. Whether to invest in the stock market now, or invest later. These are just a few of the questions that are contingent on the answer to that one all important question: where is the economy headed next? - Is it going to improve from here on, or deteriorate further?

Let's see how the world's largest and by far the most influential economy's central back fares at answering this question. As per a CNN Money report, in June 2008, the Federal Reserve's forecasts were still projecting that the US economy would avoid a recession. And that the annual unemployment rate would show little change and remain in the 5% range over the following three years.

What happened instead was that unemployment shot up like never before. It topped out at a distressing 10.1% in late 2009. And it has averaged about 9.7% so far this year (till about July 2010). As far as its forecast of the US economy avoiding a recession is concerned, what happened next doesn't need any elaboration. Not only did the US fall into one of the most severe recessions it has ever seen, it also pulled down the rest of the world along with it. In fact, June 2008, the date of its forecast, turned out to be almost seven months after the recession is now known to have begun.

And over optimism is not the only thing that the Fed has erred with. Its forecasts on the pessimistic side too have turned out to be horribly wrong. Based on its own forecasts, the Fed cut its key interest rate to 1% in June 2003 expecting things to worsen for the economy. But as per the report mentioned earlier, what followed next was the start of one of the best quarters of growth for the US economy in 20 years.

History is littered with countless other such examples.

Many economist and analysts make it their full time job to forecast the future of the economy. Thankfully, the final application of most of these forecasts is limited to just newspaper articles and headlines.

Out of all the uncertainty, one thing is certain. We are definitely not very good at forecasting the future. Whether that is the US Federal Reserve trying to figure out its monetary policy, or simply an investor trying to make decisions on whether to invest now or later. It seems to make little difference.

The ideal framework for making investing decisions, it seems, should be built without the need for having to make economic forecasts. Afterall, you wouldn't want to bet your money on such a unreliable and flimsy practice, would you?