The Goofy Origins and Dismal Track Record of Modern Economic Forecasting

In Fortune Tellers, Walter Friedman shows not only where our contemporary forecasting ecosystem came from, but also its considerable influence on present-day economic thought and practice.
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In Fortune Tellers, Walter Friedman shows not only where our contemporary forecasting ecosystem came from, but also its considerable influence on present-day economic thought and practice.
(Photo: Shutterstock)

(Photo: Shutterstock)

Today, economic forecasts are as taken for granted as weather forecasts. Financial-sector pundits on television compete to predict what the next jobs or earnings report will say, or which stocks are set to rise and fall. Government agencies and private consulting firms forecast economic ups and downs for the countries of the world for decades into the future. Some of the prophecies are free; others appear in subscription-only newsletters for investors hoping to get an edge on their rivals.

But as familiar and variegated as economic forecasting is today, there was a time not that long ago when it did not exist, as Walter Friedman shows in Fortune Tellers: The Story of America’s First Economic Forecasters. Tracing the parallel lives of business-publishing entrepreneurs, academics, and public officials, Friedman shows not only where our contemporary forecasting ecosystem came from, but also its considerable influence on present-day economic thought and practice.

Economic forecasting only diverged from traditional soothsaying in the early 20th century—a point that Friedman underlines by opening with the story of the astrologer Evangeline Adams. She became a household name at the start of the Depression, famous for the mystical investment advice she dispensed on her radio program, in her newsletter, and in a Washington Post column. The rest of Friedman’s subjects would have spurned any association with Adams: to varying degrees, each believed that he (if not his rivals) was bringing a rational, scientific approach to the uncertain craft of economic prognostication—keeping the discipline safe from quacks. And yet, Friedman writes, “their predictive accuracy was no more certain than a crystal ball.”

IN THE LATE 19TH and early 20th centuries, the emergence of giant corporations and a burgeoning stock market created demand from investors for intermediaries who could make sense of the newly complex business scene. It was becoming clear that cycles of boom and recession, though poorly understood, were not bugs but features (to use a contemporary metaphor) of the new mass-production economy. More people than ever—buyers and suppliers in the world of business, stock market speculators—were anxiously seeking guidance about where to put their money, and when. Increasingly, they were dissatisfied with 19th-century business wisdom that ascribed fluctuations not to cycles of an interrelated economy, but to “fate, the weather, political schemes, divine Providence, or external shocks like new tariffs or earthquakes.”


More than anyone else, Friedman writes, it was Roger Babson who “helped invent this complex figure, the ‘forecaster.’” Beginning in the aftermath of the financial panic of 1907, Babson built a publishing empire based around Babson’s Reports, a forecast newsletter full of statistics—everything from production figures and stock-exchange transactions to gold prices and immigration rates. His trademark was the “Babsonchart,” which visually contrasted shifts in the economy with a “normal line” representing the economy’s “natural” level of performance. The placement of this line was based on Babson’s understanding of Newtonian physics—for every action, an equal and opposite reaction—which he believed governed all human activity, and allowed him to predict where the economy was headed based on knowledge of where it had been.

Among Babson’s many business successes was the acquisition in 1908 of a rival publishing empire founded by John Moody, who had left a job at the financial house of Spencer Trask to start a business information service inspired by Poor’s (the first such firm). Unlike Babson, Moody had no overarching model or theory of economic cycles, and he never published a description of his methods. But he, too, believed the chaotic economy could be navigated only by analyzing tremendous amounts of information, including (contrary to what Babson believed) specific information about the workings of individual businesses. After Babson bought Moody’s first publishing empire, Moody made a second fortune with another, one that sold not only statistics, but also his opinions on what they meant.

Babson, Moody, and other forecasters in the financial industry soon had to contend with Irving Fisher, an ambitious professor of economics at Yale. Fisher was among the first academics to combine economics with high-level math; he believed that sufficiently sophisticated theories could reveal not only the when of economic change, but also the why, allowing enlightened business leaders to act in ways that minimized economic disruption. In the 1920s, Fisher found a mass audience with a weekly business-page insert that he sold to newspapers across the country.

Herbert Hoover, who was secretary of commerce for most of the 1920s before becoming president, liked the idea that solid data, combined with an understanding of business cycles, could show businessmen the right path. To that end, he tasked the Department of Commerce with gathering economic data on a scale that was unprecedented. Today, of course, it is a massive fixture of the forecasting ecosystem.

“Readers took forecasts on faith,” Friedman says. “There were no systematic tests of accuracy.” But in 1933, a wealthy patrician named Alfred Cowles published a detailed study of the recommendations of 24 financial publications released between 1928 and 1932. “Cowles’s research revealed no evidence that the forecasters were accurate.” Friedman writes, “Simply shuffling cards and randomly drawing one, he found, brought about a better record of stock market prediction than following the professionals’ advice. Random guesses, he concluded, were as accurate as carefully calculated predictions.”

It comes as little surprise that men who were so sure they could foresee the economic future were often drawn to enterprises that were pseudoscientific or faddish. In 1940, Babson became the Prohibition Party’s presidential candidate; in 1949 he founded the Gravity Research Foundation in order to fund research toward a “gravity insulating” device; and he developed bizarre diets. And he advocated eugenics as a means of breeding out “unfit” Americans. Fisher, too, supported Prohibition, extreme dieting (his best-selling book was a diet-and-health tome, How to Live), and eugenics; in 1922, he was one of the founders of the American Eugenics Society, and he advocated the screening of immigrants to prevent “race deterioration.”

John Moody, for his part, went on a spiritual quest that led him from Madame Blavatsky to Christian Science to Buddhism to Catholicism. “This great Mother Church of the Christian Faith has brought me the inestimable blessing of perfect peace,” he wrote late in his life. “Where all was doubt before, she gives me certainty.”

FOR ANYONE WHO SEEKS a reputation as an economic forecaster, a depression or major recession is the ultimate audit. Few of Friedman’s subjects passed. On October 28, the worst day of the 1929 sell-off that began the Great Depression, Moody’s Weekly Letter said, of the previous week’s turmoil, “We are convinced that it represents nothing more or less than a speculators’ frenzy of fear for the time being—in other words, a technical condition of the market rather than a reflection of radically changing underlying conditions, which, in point of fact, remain relatively stable.” Moody, embarrassed and struggling, gradually shifted from forecasting to security ratings. But that didn’t stop his firm’s securities-rating business from thriving; it remains one of the world’s leading rating agencies today.

Fisher suffered much more, at least as a seller of predictions. Histories of the Great Depression routinely quote his confident statement, made in New York City on October 15, 1929, that stock prices had reached “what looks like a permanently high plateau.” Following the crash, Fisher persisted in his optimism for a long time; as a result, the once-wealthy forecaster’s reputation was ruined, and he experienced a straitened old age in which he had to borrow money from a rich sister-in-law and trade his mansion in New Haven for an apartment.

His academic reputation, however, remains strong, thanks to his eventual willingness to change course and formulate the “debt deflation” theory of economic depression. This theory holds that a depression may be prolonged because households, having borrowed money to take on mortgages and to speculate in stocks, slowly pay down their debts, to the detriment of consumer demand. Now referred to as the theory of “balance sheet recession,” this is the explanation of both the Great Depression and the Great Recession held by most mainstream economists today.

Because Babson had issued warnings shortly before the crash, the Depression seemed to confirm his prowess as a prophet. But Friedman argues that Babson’s post-crash reputation needs qualification. “For one thing,” he writes, “Babson had urged his clients to get out of the market in 1926, far before the boom of 1927 and 1928. ... Had Babson’s clients followed his advice, they would have missed the real boom in stock market securities in the late 1920s.” Worse, in 1931 he confidently predicted recovery was around the corner. But years passed and no recovery came, and by the mid-1930s Babson had steered his publishing industry toward self-help.

ALFRED COWLES, THE MAN who conducted the 1933 study on the haphazardness of earlier forecasters, went on to underwrite the Cowles Commission for Research on Economics as well as the Econometric Society. Both groups were dedicated to the now-mainstream idea of using complex math to model the economy. (Fittingly, Irving Fisher was also involved.)

Ironically, it was a member of the Cowles Commission, Lawrence Klein, who in the 1950s and 1960s began to steer econometrics toward forecasting. In 1969, he even helped found a forecasting firm, Wharton Econometric Forecasting Associates. The mathematically advanced new breed of fortune-tellers proved no better at predicting, say, the stagflation of the 1970s than their predecessors had been at seeing the Depression coming. Such outfits similarly failed to foresee the recent crash. Both the Great Depression and the Great Recession, Friedman writes, revealed the “seductive belief, held by many, that today we live in a smarter and less risky era than our ancestors and that calamity will not happen to us.” This belief has been shaken, at least for the time being. But the desire to make money by anticipating tomorrow’s conditions appears perennial, and people peddling fortunes are likely to find plenty of customers.

This post originally appeared in the January/February 2014 issueofPacific Standard as "Never Saw It Coming." For more, consider subscribing to our bimonthly print magazine.