Macroeconomic Forecast Problems

macroeconomic forecasting

Prediction of aggregate economic activity

Macroeconomic forecasting involves predicting aggregate measures of economic activity at the international, national, regional, or state level. Predictions of gross domestic product (GDP), unemployment, and interest rates by "blue chip" business economists capture the attention of national media, business, government, and the general public on a daily basis.2 Other macro-economic forecasts commonly reported in the press include predictions of consumer spending,

2 GDP measures aggregate business activity as described by the value at final point of sale of all goods and services produced in the domestic economy during a given period by both domestic and foreign-owned enterprises. Gross national product (GNP) is the value at final point of sale of all goods and services produced by domestic firms. As such, GNP does not reflect domestic production by foreign-owned firms (e.g., Toyota Camrys produced in Kentucky).

business investment, homebuilding, exports, imports, federal purchases, state and local government spending, and so on. Macroeconomic predictions are important because they are used by businesses and individuals to make day-to-day operating decisions and long-term planning decisions. If interest rates are projected to rise, homeowners may rush to refinance fixed-rate mortgages, while businesses float new bond and stock offerings to refinance existing debt or take advantage of investment opportunities. When such predictions are accurate, significant cost savings or revenue gains become possible. When such predictions are inaccurate, higher costs and lost marketing opportunities occur.

The accuracy of any forecast is subject to the influence of controllable and uncontrollable factors. In the case of macroeconomic forecasting, uncontrollable factors loom large. Take interest rate forecasting, for example. The demand for credit and short-term interest rates rises if businesses seek to build inventories or expand plant and equipment, or if consumers wish to increase installment credit. The supply of credit rises and short-term interest rates fall if the Federal Reserve System acts to increase the money supply, or if consumers cut back on spending to increase savings. Interest rate forecasting is made difficult by the fact that business decisions to build inventories, for example, are largely based on the expected pace of overall economic activity—which itself depends on interest-rate expectations. The macro-economic environment is interrelated in ways that are unstable and cannot be easily predicted. Even policy decisions are hard to predict. For example, Federal Reserve System policy meeting minutes are confidential until months after the fact. Is it any wonder that "Fed watching" is a favorite pastime of business economists?

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