Economic forecasting is the process of making predictions about the economy. Forecasts can be carried out at a high level of aggregation--for example for GDP, inflation, unemployment or the fiscal deficit--or at a more disaggregated level, for specific sectors of the economy or even specific firms.
Video Economic forecasting
Overview
Many institutions engage in economic forecasting, including international organisations such as the International Monetary Fund, World Bank and the OECD, national governments and central banks, and private sector entities, including think-tanks, banks, consultants and companies. Some forecasts are produced annually, but many are updated more frequently.
Economists select which variables are important to the subject material under discussion. Economists may use statistical analysis of historical data to determine the apparent relationships between particular independent variables and their relationship to the dependent variable under study. For example, to what extent did changes in housing prices affect the net worth of the population overall in the past? This relationship can then be used to forecast the future. That is, if housing prices are expected to change in a particular way, what effect would that have on the future net worth of the population? Forecasts are generally based on sample data rather than a complete population, which introduces uncertainty. The economist conducts statistical tests and develops statistical models (often using regression analysis) to determine which relationships best describe or predict the behavior of the variables under study. Historical data and assumptions about the future are applied to the model in arriving at a forecast for particular variables.
The economist typically considers risks (i.e., events or conditions that can cause the result to vary from their initial estimates). These risks help illustrate the reasoning process used in arriving at the final forecast numbers. Economists typically use commentary along with data visualization tools such as tables and charts to communicate their forecast.
Maps Economic forecasting
Purpose
Forecasts are used for a variety of purposes. Governments and businesses use economic forecasts to help them determine their strategy, multi-year plans, and budgets for the upcoming year. Stock market analysts use forecasts to help them estimate the valuation of a company and its stock.
In conducting economic forecasts a variety of information has been used in an attempt to increase the accuracy. Everything from macroeconomic, microeconomic, market data from the future, machine-learning (artificial neural networks), and human behavioral studies have all been used to achieve better forecasts.
Sources of forecasts
Global scope
The Economic Outlook is the OECD's twice-yearly analysis of the major economic trends and prospects for the next two years. The IMF publishes the World Economic Outlook report twice annually, which provides comprehensive global coverage.
U.S. forecasts
The U.S. Congressional Budget Office (CBO) publishes a report titled "The Budget and Economic Outlook" annually, which primarily covers the following ten-year period. The U.S. Federal Reserve Board of Governors members also give speeches, provide testimony, and issue reports throughout the year that cover the economic outlook.
Large banks such as Wells Fargo and JP Morgan Chase provide economics reports and newsletters.
Combining Forecasts
Forecasts from multiple sources may be combined and published by some entities. Consensus Economics, among others, compiles the macroeconomic forecasts prepared by a variety of forecasters, and publishes them every month. The Economist magazine regularly provides such a snapshot as well, for a narrower range of countries and variables.
Forecast methods
The process of economic forecasting is similar to data analysis and results in estimated values for key economic variables in the future. An economist applies the techniques of econometrics in their forecasting process. Typical steps may include:
- Scope: Key economic variables and topics for forecast commentary are determined based on the needs of the forecast audience.
- Literature review: Commentary from sources with summary-level perspective, such as the IMF, OECD, U.S. Federal Reserve, and CBO helps with identifying key economic trends, issues and risks. Such commentary can also help the forecaster with their own assumptions while also giving them other forecasts to compare against.
- Obtain data inputs: Historical data is gathered on key economic variables. This data is contained in print as well as electronic sources such as the FRED database or Eurostat, which allow users to query historical values for variables of interest.
- Determine historical relationships: Historical data is used to determine the relationships between one or more independent variables and the dependent variable under study, often by using regression analysis.
- Model: Historical data inputs and assumptions are used to develop an econometric model. Models typically apply a computation to a series of inputs to generate an economic forecast for one or more variables.
- Report: The outputs of the model are included in reports that typically include information graphics and commentary to help the reader understand the forecast.
Forecasters may use computational general equilibrium models or dynamic stochastic general equilibrium models. The latter are often used by central banks.
Methods of forecasting include Econometric models, Economic base analysis, Shift-share analysis, Input-output model and the Grinold and Kroner Model. See also Land use forecasting, Reference class forecasting, Transportation planning, Calculating Demand Forecast Accuracy and Consensus forecasts
The World Bank provides a means for individuals and organizations to run their own simulations and forecasts using its iSimulate platform.
Issues in forecasting
Forecast accuracy
There are many studies on the subject of forecast accuracy. Accuracy is one of the main, if not the main criteria, used to judge forecast quality. Some of the references below relate to academic studies of forecast accuracy.
In early 2014 the OECD carried out a self-analysis of its projections. "The OECD also found that it was too optimistic for countries that were most open to trade and foreign finance, that had the most tightly regulated markets and weak banking systems" according to the Financial Times.
Forecasts and the Great Recession
The financial and economic crisis that erupted in 2007--arguably the worst since the Great Depression of the 1930s--was not foreseen by most of the forecasters, even if a few lone analysts had been predicting it for some time (for example, Nouriel Roubini and Robert Shiller). The failure to forecast the "Great Recession" has caused a lot of soul searching in the profession. The UK's Queen Elizabeth herself asked why had nobody noticed that the credit crunch was on its way, and a group of economists--experts from business, the City, its regulators, academia, and government--tried to explain in a letter.
List of regularly published surveys based on polling economists on their forecasts
See also
- Social return on investment
Footnotes
Further reading
- Walter A. Friedman, Fortune Tellers: The Story of America's First Economic Forecasters. Princeton, NJ: Princeton University Press, 2013. ISBN 978-0691169194.
- "The IMF and OECD versus Consensus Forecasts", August 2000. Applied Economics, 33(2), p. 225-235 Roy Batchelor (City University Business School) The IMF and OECD versus Consensus Forecasts
- "Assessment of Consensus Forecasts Accuracy: The Czech National Bank Perspective", Working Paper Series 14, 2010, December 2010 Filip Novotný and Marie Raková (both Czech National Bank) "Assessment of Consensus Forecasts Accuracy: The Czech national Bank Perspective"
- IMF forecasts can be found here: IMF World Economic Outlook, World Bank forecasts are here World Bank Global Economic Prospects, and OECD forecasts here: OECD Economic Outlook
- Two of the leading journals in the field of economic forecasting are the Journal of Forecasting and the International Journal of Forecasting
- For a comprehensive but quite technical compendium, see Handbook of Economic Forecasting, North-Holland: Elsevier, 2006
- A more compact and more accessible, but pre-crisis overview is provided in Elements of Forecasting, 4th edn, Cincinnati, OH: South-Western College Publishing, 2007
- A recent, comprehensive and accessible guide to forecasting is Economic Forecasting and Policy, 2d edn, Palgrave, 2011
External links
- CBO Budget & Economic Outlook - 2015 to 2025
- IMF - World Economic Outlook - April 2015
- World Bank - Global Economic Prospects
- Fannie Mae Economic & Housing Outlook
- OECD Economic Outlook
- FRB St. Louis-Kevin Kliesen-A Guide to Tracking the U.S. Economy-Q1 2015
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