Economic Forecasting Meaning Models Method Technique

Economic Forecasting Meaning

Economic forecasting is a process in which economists take current data from a country (or a group of them) to determine its future economic activity. These reports vary in detail, but the core is the same: they use economic indicators and models to predict the growth of an economy in the near future.

This kind of analysis is mostly done by central banks, international rating agencies, and groups like the International Money Fund (IMF). However, they are very important for investors because it helps them to determine whether or not to invest in a certain country.

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Economic Forecasting Explained

Economic forecasting has been around in many forms, along with capitalismCapitalismCapitalism is an economic system consisting of businesses, resources, capital goods, and labour. Private entities own it, and the income is derived by the level of production of these factors. Because of the private hands, these entities can be operated efficiently and maximize their production activity also.read more. However, after the Great DepressionGreat DepressionThe Great Depression refers to the long-standing financial crisis in the history of the modern world. It began in the United States on October 29, 1929, with the Wall Street Crash and lasted till 1939.read more, they increased in importance, as private companies and the government learned the dangers of not predicting a major recession. They, therefore, started to put efforts into avoiding the possibility of one.

Key Takeaways

Economic forecasting involves using data and indicators to determine how much an economy will grow in the future.Most of the time, this process is used to determine the expected growth (or decrease) in the GDP of the next quarter or year.Economic forecasting models can be causal, qualitative, or use a time series. Sometimes, economists use several models to check whether the economy is moving as they think or not.Both the private and the public sector benefit from looking at the analysis, as it helps them to determine what actions they may take in the following years if they have a better grasp of how the economy will evolve.

Trade organizations and investors also keep a close look at these reports. This way, they can decide when to invest and what actions to take to avoid a recession or enjoy growth more profitably. For example, a consumer will save up more if the forecasts and the prevailing trends hint at a further rise in prices and the unemployment rateUnemployment RateThe unemployment rate formula calculates the share of people who are not working or are jobless of the total employed or unemployed labour force and is depicted as a percentage. Unemployment Rate = Unemployed People / Labor Force * 100 read more. This was evident during the period of Covid-19 when many people started saving up or increasing their savings as the economy struggled to keep industries running in the wake of a worldwide lockdown.

The pandemic had crippled the global economy, and as a result, many people lost their jobs. In addition, some of the developing countries showed alarmingly negative GDP. All of this gave an indication or a forecast that things would not look up in the future. It resulted in increased taxes in some countries and people saving up more for possible rainy days.

Preparing an economic forecast

Economists gather historical data points from previous reports to forecast the economy. It includes employment rates, inflation, interest ratesInterest RatesAn interest rate formula is used to calculate loan repayment amounts as well as interest earned on fixed deposits, mutual funds, and other investments. It is also used to calculate credit card interest.read more, risks to the economy’s stability, and other macroeconomicMacroeconomicMacroeconomics aims at studying aspects and phenomena important to the national economy and world economy at large like GDP, inflation, fiscal policies, monetary policies, unemployment rates.read more data.

Then, they review the current literature about the subject and measure them using moving averagesMoving AveragesMoving Average (MA), commonly used in capital markets, can be defined as a succession of mean that is derived from a successive period of numbers or values and the same would be calculated continually as the new data is available. This can be lagging or trend-following indicator as this would be based on previous numbers.read more, regressive analysis, or other techniques. Finally, they use an economic model to see how strong the current growth is and whether there’s a reason for it to continue.

These reports often use the information to determine either a quarterly or annual gross domestic product (GDP)Gross Domestic Product (GDP)GDP or Gross Domestic Product refers to the monetary measurement of the overall market value of the final output produced within a country over a period.read more growth. However, the same process (although with other variables) can also determine other data such as inflation.

Limits of Economic Forecasting

Despite the importance of economic forecasting, economists know that it’s impossible to predict the future with 100% certainty. Human factors and unexpected social developments, such as a pandemic, for example, are hard to predict.

So, economic forecasting remains an important tool. Still, it may not be enough to detect a full-scale crisis even though it works efficiently to see trends that do not involve the worst crisis. The government is therefore at a complete loss when anticipating many financial crises.

After the crisis of 2008, for example, the Queen of England asked why nobody noticed the recession before it happened. A study made by the IMF that analyzed cases between 1992 and 2014 may answer the question proposed by the Queen. The conclusion was that experts often miss the magnitude of big crises and are surprised when they appear. Another interesting finding is that public and private analyses tend to make mistakes with a similar recurrence.

A few economists like Nouriel Roubini, the famous “Dr. Doom,” were able to predict the major downtime in the economy. However, he was heavily criticized, and his work was only valued afterward.

Models of Economic Forecasting

There are several methods of economic forecasting available. They include causal, qualitative methods, and the examination of time series methods, among others.

Causal models often use regression analysisRegression AnalysisRegression analysis depicts how dependent variables will change when one or more independent variables change due to factors, and it is used to analyze the relationship between dependent and independent variables. Y = a + bX + E is the formula.read more, from simpler models to multiple regressionMultiple RegressionMultiple regression formula is used in the analysis of the relationship between dependent and numerous independent variables. Formula = y = mx1 + mx2+ mx3+ bread more. They determine the future by establishing a relationship between sets of data collected from the near past. On the other hand, qualitative methods may include surveys, cross-referencing macroeconomic data, etc.

The methods based on time series try to determine growth by picking up on trends and determining moving averages.

Economic forecasting models include the Grinold and Kroner Model, the input-output model, calculating demand forecast accuracy, etc.

One can also combine different types of forecasts to get a consensus forecast. First, several specialists study the subject. And then, someone gathers all the data and uses a large volume of studies to determine the consensus in the scientific community.

It’s also essential to note the subjectiveness of economic forecasting. For example, different individuals may follow distinct economic theories and diverge on whether government spending is bad or good for the economy. It means that one may interpret the same data differently.

Real-World Examples

Let’s take a look at some real-world examples of economic forecasting to understand it better.

United States

The OECD forecasts a growth of 3.7% for the United States in 2022. According to the OECD, the reason for such optimism is an increase in wages, housing rents, shipping rates, and the easing of the coronavirus outbreak, which will lead to an overall consumer price growth.

UK

According to the UK regional economic outlook, the United Kingdom is also set for a dramatic rebound. The January 2022 report suggests that the economy will grow by 3.8%, mostly due to the ending of the pandemic. However, the inflation rateInflation RateThe rate of inflation formula helps understand how much the price of goods and services in an economy has increased in a year. It is calculated by dividing the difference between two Consumer Price Indexes(CPI) by previous CPI and multiplying it by 100.read more will be 5.2% in 2022 and might decrease to 2.4% in 2023.

Australia

The Reserve bank of Australia believes that the country will grow its GDP by 5.5% over 2022 and 2.5% over 2023. The unemployment rate hopefully declines in 2022. However, the inflation rate might encounter a slight rise in the coming years. In addition, most economists are wary of the country’s relationship with China, which has deteriorated.

Canada

The OECD predicts an economic recovery for Canada with a growth of 3.9% in 2022 and 2.8% in 2023. However, the inflation may linger a while longer and hinder the anticipated acceleration.