Cutting-Edge Leadership

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The Folly of Economic Forecasting and Analysis: Are You Kidding?

What is the psychology behind financial analyses? There's plenty.

OK. I can't take it anymore. I've been listening to the morning news and hearing the so-called financial analysis. There is good economic news. Housing sales were up a surprising 9 percent, and Amazon had record profits. But, the stock market is down. So what do the analysts say? Well, although housing is up, investors are concerned that this is all fueled by the new buyer incentives in the federal stimulus package. IF, this program doesn't continue, then, the analysts tell us, investors believe that housing sales will drop in the future and that's why the market is down.

The crazy thing is that this convoluted analysis is being shared by a lot of different news outlets - all of the various stations are repeating this same analysis. It is the very worst of "armchair quarterbacking after the fact." These so-called analysts know the outcome - the stock market is down - and they know some high-profile positive data (Amazon and housing purchases are up), and they try to explain it after-the-fact. As any psychology research methods student can tell you: This is bad methodology.

It is good that in the field of Economics, behavioral economics is the hot, growing area. That is because there is so much psychology that governs the world of finance and markets. People don't always behave rationally, as many economic models suggest. Psychologists study why and how people make systematic errors and have biases in their judgments and interpretations. And these economic analysts in the media are subject to one of these - explaining things after the fact. The folly of that is that any crazy explanation fits, and there is no way to determine if they are right or wrong.

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How about predicting the future? Well that is certainly folly. There are now a number of economic specialists who say that they did indeed predict the economic crash, and they can prove that they acted beforehand. But here's the issue: the majority did not. There are simply too many variables, including many psychological variables, in operation that make it nearly impossible to predict the future. But, we will continue to hear these after-the-fact analyses, and these economic predictions. And, some of them will come true, because, after all, if you predict all possible outcomes, someone will be right. And, psychologists know that there is such a thing called the "self-fulfilling prophecy." If enough people are predicting an outcome, and broadcasting it widely in the media, people will act in a way that causes the prophecy to come true. How about a remedial course in Psychology for these analysts?

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www.twitter.com/#!/ronriggio

Ronald E. Riggio, Ph.D., is the Henry R. Kravis Professor of Leadership and Organizational Psychology at Claremont McKenna College.

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