Some bad news for good news — Optimistic forecasts create recessions

Positive forecasts lead the public and private sector to ‘celebrate’ by borrowing more, says IMF paper

By Georgi Kantchev, Jun 5, 2018

Good economic forecasts may be too much of a good thing: They could help cause a recession.

That’s according to a new International Monetary Fund working paper, which says that over-optimistic economic growth forecasts—including the IMF’s own—could help cause recessions and fiscal problems. The IMF argues that positive forecasts lead the public and private sector to “celebrate” by borrowing more, which encourages the sort of debt accumulation that builds frailties in the economic system, harming growth.

“Over-optimism brings economic damage in later years,” the authors write. “An overestimation of the future rate of economic growth could provide a short-run boost to the economy, but it also increases the subsequent probability of a recession and other economic difficulties,” they say.

The paper, written by Paul Beaudry, professor at the University of British Columbia, and IMF economist Tim Willems, uses a sample of forecasts for 189 countries made by the biannual IMF World Economic Outlook publication between 1990 and 2016.

The authors calculate that, on average, forecasts for next year’s gross domestic product growth have been 0.58 percentage points higher than the actual number. Research shows that such an upward bias is also present in forecasts made by private sector economists such as banks, the paper says.

The IMF has also missed most recessions in its forecasts, predicting only 24% of recessions one year ahead of the event.

The IMF’s analysts aren’t the only ones to notice that their own profession can get it wrong. In financial markets, analysts last year wildly underestimated gains on the S&P 500. Gold hasn’t followed the script of the almost yearly predictions for higher prices. This year’s oil rally caught forecasters by surprise.

But the IMF paper goes a step further, arguing that forecasts could take an actual economic toll. IMF forecasts play a central role in policy circles, governments and businesses frequently use them for spending decisions. That “implies that they can affect macroeconomic outcomes,” the authors say.

Write to Georgi Kantchev at georgi.kantchev@wsj.com