31 March 2015

Fortune Tellers: The Story of America’s First Economic Forecasters

Walter A. Friedman
2013, Princeton University Press, 288 pages, £19.95
ISBN 9780691159119

Reviewer: Ian Harwood, Independent Consultant

Economic forecasting has been a massive growth industry in recent decades, attracting a host of talented economists. In the 1950s and the 1960s the activity of predicting future macro-economic conditions was largely the preserve of national governments, inter-governmental organisations such as the OECD and various semi-official think-tanks, with private sector efforts largely confined to economists employed by large industrial companies. During the 1970s, however, financial institutions began to develop their capabilities in this sphere and the number of forecasters has multiplied many times over in subsequent decades. The sheer numbers surveyed regularly by news-providers such as Reuters or Bloomberg to establish the latest economic consensus illustrate this clearly.

 It is exceptionally instructive, therefore, to take a step back in time to the early years of 20th century America, when the ‘science’ of economic forecasting was in its infancy, to see why, and in what fashion it developed. This is the subject of Friedman’s The Fortune Tellers. And it constitutes a fascinating and wholly engrossing tale.

 Friedman’s approach is to present in turn the key and idiosyncratic dramatis personae of the time, including such still-remembered figures such as Wesley Mitchell and Irving Fisher alongside others who are nowadays less familiar such as Roger Babson and John Moody (the founder of the eponymous rating agency). Other people such as future US President Herbert Hoover also figure prominently in the narrative.

Especially interesting – particularly to economists currently engaged in forecasting – is Friedman’s outline of the various approaches employed almost one hundred years ago. These may seem primitive by modern-day standards but were nonetheless diverse and, without exception, insightful. One illuminating aspect of Friedman’s work is to draw out why those who purveyed economic forecasts managed to prosper, often to an extraordinary degree. The US recessions of the pre-World War I period had been acute and discomfiting, and that of 1920/21 which followed was especially so. Understandably, therefore, there was massive interest in the ‘business cycle’. And those running businesses proved willing to pay generously for predictions of whether prosperity or, alternatively, a severe economic reversal lay just around the corner.

 Appetite for forecasts of the likely evolution of the US business cycle also came from stock market investors. By this time the US enjoyed the highest standard of living in the world. And then – as now- a large proportion of the population was eager to invest in America’s fast-rising prosperity by buying shares in US Inc. Accordingly, the economic forecasters developed their business models to meet this demand by providing forecasts for Wall Street as well. All was fine and dandy as long as the economy and stock market boomed – as both did, of course, during the “Roaring Twenties”. Popular faith in the benefits of technological innovation soared. And the self-serving conviction took hold that the business cycle has been tamed and that periodic recessions were a thing of the past.

As we have discovered many times since, however, when Hubris pre-dominates, Nemesis is never many steps behind. And the come-uppance for those who had built extraordinarily successful economic forecasting enterprises and franchises during economic and stock market boom of the 1920s was their collective failure to anticipate either the October 1929 Wall Street Crash or the recession that accompanied it.

Admittedly, the unparalleled severity of America’s Great Depression owed a great deal to policy mistakes – notably (as Friedman and Schwartz so comprehensively demonstrated some thirty years later) by allowing the banking system to fail. Nonetheless, the persistent over-optimism of the most popular economic forecasters, even as the Great Depression was underway, did them no favours.

Present-day forecasters, however, shouldn’t view this past collective failure with any complacency. To the best of my knowledge, no post-war US recession has been anticipated beforehand by the majority of macro-economic forecasters!

Overall, Friedman’s book comprises a comprehensive chronicle of the genesis of modern-day economic forecasting and is highly recommended, both to current practitioners and to those with a more general interest in such matters.