Reviewing forecasts

Economic forecasting is a worthy business. It helps governments, central bankers and companies take key day-to-day decisions about policies, investments, levels of spending, interest rates and so on. There is a rich and diverse supply to choose from, both in the public and private sectors. Whole businesses thrive on it and some major television networks have even turned watching the economy into a form of mass entertainment.
Where does the OECD stand? The organisation is one of the world’s foremost economic institutions, with its biannual Economic Outlook serving as a reference for many banks, investment houses, publishers and consultancies, not to mention governments the world over. Online, it remains one of the OECD’s most consulted publications.But how accurate are our forecasts? Do projections, say, for GDP growth turn out to be close or wide off the mark? And while economic forecasters earn their crust assessing everyone else’s performance, who assesses them?An online end-year league table from the economics editor of the Sunday Times in London gives a useful media perspective. It awards marks for accuracy on forecasting growth, inflation and other key variables for the British economy. For 2006 the OECD stood in eighth place out of some 50 institutions. It was the best non-British performer, and one of only two public institutions in the top 10, the other being the National Institute of Economic and Social Research in seventh place. The European Commission’s forecasts ranked 12th and the IMF’s 13th.click here for larger graphThis strong showing is for a single year but concords with a recent study carried out by Lukas Vogel of the OECD Economics Department, which shows a good OECD record for predicting GDP for all of the G7 countries over the 1991-2006 period.Mr Vogel finds that the OECD Economic Outlook released in the spring has tended to predict growth for the year in progress relatively accurately, and has added useful information to help improve subsequent forecasts. However, looking forward one year out, both the spring and autumn Economic Outlooks have tended to err on the optimistic side.Economic forecasting is as much an art as a science. Economists use a wide range of models combined with high-frequency data to predict economic variables as well as standard relationships between those variables, whether within a country, such as the link between interest rates and investment–or between trade partners–how much rising demand in one market will raise exports in another for instance. But while economics relies on mathematic models, it is not in itself a pure science. It demands a sense of judgement, and an ability to marry theory with an ever-changing reality. Many economists will say that what counts most in economic forecasting is not so much precise outturns as getting the big picture right: is an economy set to expand fast or slowly, or is inflation on course to rise or to fall and what are the policy implications? Mr Vogel shows that OECD projections have in general correctly predicted accelerations and decelerations of GDP growth in the G7. However, the real difficulty lies in anticipating turning points. Forecasts for the year in progress have accurately captured most cyclical up- or downturns, but turning points a year down the road are rarely anticipated.Accuracy of projections for the year ahead can be improved, notably by looking more closely at potential growth and giving more weight to initial cyclical positions, Mr Vogel argues. Economists are often loathe to adjust projections downward quickly enough during slowdowns, he points out, and this leads them to over-estimate outcomes during low-growth spells. It may also lead them to miss those turning points.Looking at other international institutions, Mr Vogel notes that European Commission GDP projections also score well, coming in slightly better than the IMF’s although behind the OECD’s. Timing is a factor, however, since IMF forecasts are carried out a little earlier in the year and therefore rest on more restricted information sets.  RJC
References
  • Vogel, Lukas (2007), “How Do the OECD Growth Projections for the G7 Economies Perform? A Post-Mortem”, OECD Economics Department Working Paper, No 573, Paris.
©OECD Observer No 267 May-June 2008


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