What is an economic forecast?
Economic forecasting is the process of attempting to predict the future state of the economy using an important and widely followed combination index.
Economic forecasting involves building a statistical model with several key variable or indicator inputs, usually to derive future gross domestic product (GDP) growth rates. Key economic indicators include inflation, interest rates, industrial production, consumer confidence, worker productivity, retail sales and unemployment.
- Economic forecasting is the process of trying to predict the future state of the economy using a widely followed combination of indicators.
- Economic forecasts are used by government officials and business managers, respectively, to determine fiscal and monetary policy and to plan future business activities.
- Because politics is highly partisan, many rational people are skeptical of economic forecasts made by the government.
- The challenges of economic forecasting and subjective human behavioral aspects also lead private sector economists to often make incorrect forecasts.
How Economic Forecasting Works
Economic forecasts aim to forecast quarterly or annual GDP growth rates, the top-level macro data for many businesses and governments to make decisions about investment, hiring, spending, and other important policies that affect overall economic activity.
Business managers rely on economic forecasts as a guide for planning future business activities. Private sector companies may have in-house economists focused on the forecasts most relevant to their particular business (for example, a shipping company wants to know how much GDP growth is driven by trade.) Or, they may rely on Wall Street or academic economists, those affiliated with Think tanks or boutique consultants.
Understanding the future is also important for government officials to help them determine which fiscal and monetary policies to implement. Economists employed by federal, state or local governments play a key role in helping policymakers set spending and tax parameters.
Because politics is highly partisan, many rational people are skeptical of economic forecasts made by the government. A case in point is the long-term GDP growth projection assumption in the US Tax Cuts and Jobs Act of 2017, which forecasts a fiscal deficit that will be much smaller than independent economists estimate, which will lead to future generations of Americans. Burden – has a huge impact on the economy.
Limitations of Economic Forecasting
Economic forecasting is often described as a flawed science. Many suspect that economists working for the White House are forced to comply, creating unrealistic scenarios to try to justify the legislation. Are the inherently self-serving economic forecasts of the federal government accurate? As with any prediction, time will tell.
The challenges of economic forecasting and subjective aspects of human behavior are not limited to governments. Economic forecasts issued by private sector economists, academics, and even the Federal Reserve (FSB) vary widely. Ask Alan Greenspan, Ben Bernanke, or well-paid Wall Street or Ivory Tower economists what their GDP forecasts were for 2006, 2007-2009 (the Great Depression).
Economic forecasters have a history of neglecting to predict crises. Economists have failed to predict 148 of the past 150 recessions, according to Prakash Loungani, assistant director and senior personnel and budget manager at the International Monetary Fund (IMF).
This inability to detect an impending recession reflects pressure on forecasters to tread carefully, Loungani said. He added that many would rather not stray from the consensus because bold predictions could damage their reputations and could cost them jobs.
special attention items
Investors should also not ignore the subjectivity of economic forecasting. Forecasts are largely influenced by the type of economic theory the forecaster accepts. For example, one economist believes that business activity is determined by the money supply, while another believes that huge government spending is bad for the economy.
The forecaster’s personal theory of how the economy works determines which types of indicators will receive more attention, which can lead to subjective or biased forecasts.
Many conclusions do not come from objective economic analysis. Rather, they are often influenced by individuals’ beliefs about how the economy and its participants work. This inevitably means that the impact of certain policies will be judged differently.
History of Economic Forecasting
Economic forecasting has been around for centuries. However, it was the Great Depression of the 1930s that gave rise to the level of analysis we see today.
After that disaster, a greater responsibility was placed on understanding how the economy worked and where it was headed. This has led to the development of richer statistical and analytical techniques.