What Is Economic Forecasting?
Let me explain economic forecasting to you directly: it's the process where we try to predict the economy's future conditions by combining various indicators.
We build statistical models with inputs from key variables, mainly to estimate future gross domestic product (GDP) growth rates. The primary indicators include inflation, interest rates, industrial production, consumer confidence, worker productivity, retail sales, and unemployment rates.
Key Takeaways
- Economic forecasting is the process of attempting to predict future conditions of the economy using a combination of widely followed indicators.
- Government officials and business managers use economic forecasts to determine fiscal and monetary policies and plan future operating activities, respectively.
- Since politics are highly partisan, many rational people regard economic forecasts produced by governments with healthy doses of skepticism.
- The challenges and subjective human behavioral aspects of economic forecasting also lead private-sector economists to regularly get predictions wrong.
How Economic Forecasting Works
Economic forecasting has existed for centuries, but the Great Depression of the 1930s really pushed it to the analytical levels we see today.
After that event, there was a stronger emphasis on understanding how the economy functions and its direction, which led to richer statistics and techniques.
These forecasts focus on predicting quarterly or annual GDP growth rates, the top macro number that businesses and governments use for decisions on investments, hiring, spending, and policies affecting overall economic activity.
As a business manager, you would rely on these forecasts to guide your future operations. Private companies might have in-house economists focusing on relevant forecasts, like a shipping company checking GDP growth driven by trade. Or they could use Wall Street, academic economists, think tanks, or consultants.
For government officials, understanding the future is crucial for setting fiscal and monetary policies. Economists in federal, state, or local governments help set spending and tax parameters.
Given the partisan nature of politics, you should view government-produced economic forecasts with skepticism. Take the U.S. Tax Cuts and Jobs Act of 2017, where long-term GDP growth assumptions projected a smaller fiscal deficit than independent estimates, with major economic implications.
Limitations of Economic Forecasting
Economic forecasting is often called a flawed science. Many suspect that economists in places like the White House are pushed to create unrealistic projections to support legislation.
These challenges aren't just in government; private-sector economists, academics, and even the Federal Reserve Board have made wildly inaccurate forecasts.
Forecasters particularly struggle to predict crises. Prakash Loungani from the IMF notes that economists failed to predict 148 of the past 150 recessions.
This failure stems from pressures to play it safe, as Loungani explains. Forecasters often stick to the consensus to protect their reputations rather than making bold predictions.
Special Considerations
You shouldn't ignore the subjective side of economic forecasting. Predictions depend heavily on the forecaster's economic theory.
For instance, projections can vary greatly between an economist who thinks business activity comes from money supply and one who sees heavy government spending as harmful to the economy.
A forecaster's personal theory dictates which indicators they emphasize, which can lead to subjective or biased projections.
Many conclusions aren't from objective analysis but are shaped by personal beliefs about the economy and its participants, meaning policies get judged differently.
What Is the Economic Forecast for 2024?
Forecasts for 2024 vary widely due to experts' differing views. The OECD, an intergovernmental group of 38 high-income countries including the US, UK, and Australia, projects global GDP growth at 3.1% in 2024 and 3.2% in 2025.
How Do You Make an Economic Forecast?
You ground economic forecasts in key indicators, both macro and micro, including inflation, interest rates, unemployment, production, and prices for goods and services.
How Can Economic Growth Be Measured?
The most common way to measure economic growth is through gross domestic product (GDP). The year-over-year GDP growth rate indicates economic expansion over time.
The Bottom Line
Economic forecasting lets policymakers, businesses, and individuals predict the economy's future based on metrics like unemployment, inflation, sales, and consumer confidence.
It's vulnerable to bias and subjectivity, so it can fail to spot economic headwinds or predict crises accurately.
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