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Economic Forecasting

Updated on January 25, 2024
Reviewed byDheeraj Vaidya, CFA, FRM

What Is Economic Forecasting?

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.

Economic Forecasting Definition

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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.

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.

Economic Forecasting Explained

Economic forecasting techniques 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.

Economic forecasting models work by following the idea that it’s possible to determine its future prosperity by analyzing data about the economyEconomyAn economy comprises individuals, commercial entities, and the government involved in the production, distribution, exchange, and consumption of products and services in a society.read more. This analysis is fairly important for both the private and public sectors. By using economic forecasting, governments can create well-informed economic, monetary, and fiscal policies, for example.

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.

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.

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Models

There are several methods of economic forecasting available. These economic forecasting models include causal, qualitative methods and examining time series methods.

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 economic forecasting models 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.

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 of macro economic forecasting are helpful to policymakers and organizations. They 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.

Types

The economic forecasting techniques may be of different types as given below:

  • Industry or sector forecasting – this involves evaluating and estimating the industry trends, economic and financial condition, etc to increase sales and production, employment and investment opportunities within an industry.
  • Macroeconomic forecast – This means forecasting the inflation rates, GDP growth, exchange rate, expansion of job opportunities so that the policymakers and the central banks can formulate strategic decisions based on this macro economic forecasting.
  • Financial market – Forcasting the financial market is extremely crutial. The stock and asset prices, the bond yields and exchange rate fluctuations help the financial institutions and banks to design portfolios for investment with minimum risk and maximum return.
  • Consumer behavior – This identifies the demand and supply levels, changing tends and patterns of consumer choices, consumption levels, consumer confidence, purchasing power and demographic trends. This helps in production level and resource planning and designing sales and marketing strategy.
  • International economic forecasting – This helps in predicting the international relations and opportunity to develop trade and commerce at a global level. It assesses the impact of international trade on the domestic industries and provides ideas for global trade, formulating policy decisions and identifying markets for investments.

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.

Importance

Let us look at the importance of forecasting or predicting the economic conditions of a country.

  • Forecasting the economic condition of country is extremely important in order to understand the country’s financial condition and take important decisions for its well-being and overall development.
  • It helps the policy makers take decisions regarding the citizen, businesses and overall growth and expansion. In provides insight into the inflation rates, GDP growth and job opportunities.
  • Through economic forecasting companies, an organization can make plans for the production levels, investment strategies and pricing techniques and levels and design policies and methods to steer the ecoomy towards the right direction.
  • It provides opportunity for risk management and control economic fluctuations. The investors are able to use these forecasts to evaluate the market conditions and adjust their investment portfolios so as to earn maximum profit with limited risk.
  • Economic forecast help in resource allocation and budgeting. The government of any country needs to be able to allocate and use its resources efficiently so there is no wastage and resources are used for growth, development, and expansion. Funds should be given to the sectors that need them most and have future potential to grow.
  • This forecast provides the ideas to invest into the public utility services in the economy. It helps in investing and growth in critical areas like education, healthcare, transport and other social welfare services.
  • Forecasting leads to market research for formulating and developing sound strategies for business. Economic forecasting companies use forecasted data for identifying growth opportunities, evaluating potential of goods and services to meet demands and develop sales methods accordingly. It aids in assessing consumer behavior, consumer’s purchasing power and and current market trends.
  • The level of international relation and development of trade and commerce, assessment of the economic and political condition of the trading partners, the export policies and opportunities and the impact of trade development on the domestic industries can be assessed using the forecasted data. It helps in controlling risk of international investment, increase collaboration and improve bilateral relations.

Limits

Here are some of the drawbacks of the process.

  • 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.

Thus, it should be noted that the process is not without any drawbacks. It uses various historical data, models and assumptions that also has varied number of uncertainties. Still, it is a very important step which provides valuable inputs and guidance in the decision-making process in both private and public sectors for better economic planning and management.

Frequently Asked Questions (FAQs)

What is the economic forecasting method?

The method of using current economic data of an economy to predict how well it will do in the future is called economic forecasting. Economists use various tools and indicators to forecast the future status of an economy. However, it is mostly used to predict an economy’s growth in the near future calculated in terms of its GDP.

Why is economic forecasting important?

Governmental organizations, rating agencies, and private companies make use of the economic forecasts to make important decisions that are likely to bring benefits and avoid undesirable economic crises like inflation. Getting an idea about the future conditions is immensely helpful to make intelligent decisions regarding finance.

What are economic forecasting techniques?

There are several economic forecasting techniques that help one make accurate future predictions like consensus forecasts, Grinold and Kroner model, input-output model, etc. The models can be causal, qualitative, or based on a time series.

This has been a guide to what is Economic Forecasting. We explain its models along with examples, importance, types and limits. You may also have a look at the following articles to learn more –