Economics Weekly - Are economic growth forecasts any use? Weekly economic data preview - Risk of recession grows
Economics Weekly 8 September 2008
Are economic growth
forecasts any use?
How accurate are
economic growth forecasts and does it matter?
There is a lot of attention
being placed on economic growth forecasts at present, not surprisingly since
growth is slowing sharply and policy makers, companies and individuals want an
idea of what is going to happen next so that they can plan ahead. We have
looked at forecasts of economic growth in the UK, US and Germany (as a proxy for the
Eurozone) for the last decade. The results show that great care should be taken
in using, and interpreting, economic growth forecasts. For instance, it is
shown that the consensus forecast, which is judged more accurate than the
individual forecasts that make it up, is rarely, if ever, actually spot on. In
fact, for the period 1999 to 2007 (we estimate 2008), for the three countries
assessed in this analysis, the consensus did not accurately predict the actual
outcome once. Charts a to c show that forecasters were close some of the time
but tended to be wrong all of the time. For the UK, see chart a,
forecasters tended to consistently underestimate actual gdp growth (i.e. they
are pessimistic), with the outturn being more often above the forecast line
than not. For the US, the opposite was
true, forecasters tended to keep overestimating growth (i.e. they are
optimistic). Germany was a mixture of the US and the UK.
This is not to say that
individual forecasts were not correct (we did not look at them all), but the
same forecaster rarely gets it right consistently, otherwise everyone would
tend to follow that forecaster and the consensus estimate would improve. So,
if, as our analysis shows, this is not the value of gdp forecasts, what is?
That seems to be in getting the direction of the change in economic growth
right and, by implication, the analysis of the reasons for this.
Forecasts of gdp are
not accurate relative to the actual outturnâ€¦
Table 1 shows some
summary statistics for gdp forecasts for the US, UK and Germany. Forecasts were taken from
the December edition of Consensus Economics for the year ahead. The average
standard forecasting error for gdp in the three economies is 1 percentage point.
In other words, if the consensus gdp forecast is 2%, the average error of past
forecasts (comparing the forecast in each year with the actual outcome)
suggests, with an equal level of confidence, that the actual outcome could be
1% or 3%.
The forecasting error
for the UK is the lowest, at 0.7
percentage points, and so differences of 0.7 percentage points or less either
side of the consensus forecast are not significantly different from each other.
The standard error is highest for Germany, at 1.2 percentage
points either side of the consensus, and 1.1 percentage points for the US. The standard
deviation, the dispersion of the actual gdp figures from its mean over the
period, is close to the error of the forecasts at around 1%, showing that
actual gdp growth can and does vary, on average by 1 percentage point, each
year from its mean value. This gives a feel for the â€˜normalâ€™ variability to be
expected in these sorts of numbers. It is highlighting that gdp is a large
number and that a small change in its value can lead to big percentage variations
in its growth rate from year to year. The value of gross domestic product in
the US economy in 2007, for instance,
was $13.8 trillion, for the UK it was $2.8 trillion
and for Germany the figure was $3.3
trillion at current prices and at market exchange rates.
â€¦but many outcomes fall
within the forecast rangeâ€¦
Table 1 also shows that
in none of the countries analysed was the consensus forecast of economic growth
actually spot on compared with the actual outturn in any of the years in the
period. For the UK, see chart d, the
actual gdp growth rate was outside of 1 standard error only twice in the last
decade. It was the same for the US, chart e, but Germanyâ€™s actual outcome,
chart f, was outside of its forecast range four times in the last decade, much
the worst forecasting record. We think the lesson from this is not to focus too
much on the actual spot gdp forecasts so much as on whether it is close to the
consensus or not. And, moreover, do not focus on whether it is higher or lower
than the consensus, but on the extent of the difference from the consensus. The
greater the difference from the consensus, the more likely it is to be right,
or wrong. In other words, a truly radical forecast is not one that is within 0.7
percentage points of the mean UK forecast for 2008 of
1.4% currently, but one that is outside of that range, i.e. less than 0.7%
growth this year or more than 2.1% growth. Looking at the August 2008 consensus
shows that none of the 29 forecasters are outside this range.
But since we are into
the second half of 2008, the likelihood of a truly remarkably different outcome
from the consensus is significantly decreased, so how about 2009? The latest
consensus forecast for 2009 is for UK gdp growth of 0.9%.
How many lie outside of the 0.7 percentage points error range? The answer is 4
forecasters, or just 13.8% of the total. In other words, roughly 86% of the
forecasts are clustered within the standard error for UK gdp forecasts (of the
4 dissenting forecasts, 1 is looking for an outright fall in output growth of
nearly 2%, while 3 are looking for growth of 1.8-2.0%). For the US in 2009 this figure is
96% of forecasters (just 1 outside the average forecast error), for Germany the figure is 100%,
with an average for the whole group of 94%. This just proves how forecasters
â€¦but the best use of
gdp forecasts is in indicating the direction of gdp growth and the reasons for
If forecasters are
bunched together and are never actually completely accurate, what use are they?
The answer lies in the direction of the forecasts. Table 1 shows that consensus
forecasts get the direction of the move in economic growth correct 77% of the
time, much better than a toss of the coin (for the other 23% there is no
overall directional bias, but in the UK, forecasts tend to be pessimistic, for the
US, optimistic and no bias for Germany. So the perfect forecast is not just one
that gets the direction right but one that gets the size of the move right as
well. That happens all too rarely, but at least users of economic forecasts,
and economic forecasters themselves, should bear in mind some of these features
of gdp forecasts when talking to users of their forecasts. This might help to
avoid the trap of talking about gdp forecasts as if they are radically
different when in reality they are not.
Sterling is unlikely to
find support from economic data releases this week, as annual producer price growth
will remain very strong but interest rates cannot be raised, BRC retail sales
stay weak and the global trade deficit hover around Â£7.5bn. In addition, the
quarterly Bank of England inflation expectations
survey will almost certainly confirm a strong rise. The MPC testifies to the
Treasury Select Committee, attracting interest on Thursday. In the Eurozone,
the ECB publishes its monthly report, spelling out the economic forecast given
by ECB President Trichet at last week's press
conference, while his
testament to the European Parliament's Committee on Wednesday will keep markets
alert. Whilst digesting the implications of Friday's very weak US monthly labour report,
focus this week turns to the still large US trade deficit, August
retail sales growth and the SeptemberUniversity of Michigan consumer confidence
survey. Following the RBA's decision to cut Australian interest rates by 0.25%
to 7% last week, New Zealand's central bank is likely
to follow suit and cut rates by 0.25% to 7.75%, as the pace of economic growth
â€¢ The surprise revision
in UK Q2 GDP growth from +0.2% to flat and market perceptions of a more serious
downside risk to H2 growth, following publication of the BoE's August inflation
report and a plethora of weak business surveys and housing activity reports,
have quickened the pace of sterling's decline. But along with more widespread
concern about recession, near-term inflation expectations have risen. Data to inform on growth/inflation
trends this week include August producer prices, which may come off peak
levels, but remain extremely high by historic standards. This price data will highlight
concern about the pass through to CPI inflation on the one hand, and on the
other, the possibility of further margin compression in the UK corporate sector as weak
market growth forces many companies to absorb higher input costs. Also due, the
market consensus for industrial and manufacturing output in July is for both to
contract by 0.1%, but we expect a rise. On the consumer side, another weak BRC
retail sales like-for-like survey may dim the retail sales outlook, while the
RICS house price index may fall to -85 in August from -83.9 in July, consistent
with declines in other published house price indices. Finally, the UK's global trade deficit
may narrow slightly to -Â£7.5bn in July from -Â£7.7bn in June, but the deficit
may improve more rapidly in the months ahead because of slower economic growth,
retrenchment in commodity prices and more competitively priced exports due to
the weaker pound.
â€¢ Focus on the US jobs market
intensified following publication of a weak August labour market report. Non farm
payroll jobs fell by 84,000 and there were significant downward revisions to
the previous two months' figures. Moreover, the unemployment rate rose sharply
to 6.1% from 5.7% in July, the highest level in five years. The important thing
here is that employment always responds with a lag to weaker GDP growth, so the
risk is that job cuts become more widespread. In terms of this week's data,
retail sales may have increased in August and the University of Michigan consumer confidence, also
for August, may have picked up slightly from 63.0 to 63.5 (above June's low of
56.4). But it may be difficult to divert market attention away from concern
over US job losses. Net exports
have supported growth this year, but the US trade deficit may have
widened in July to $58.0bn from $56.8bn in June, partly because oil import
prices peaked in mid-July.
â€¢ The ECB kept its repo
rate at 4.25% last week, while President Trichet re-affirmed its neutral policy
bias. By focusing on the growing risk of second round price effects, the ECB is
keen to dent hopes of wage growth in the wake of IG Metall, Germany's engineering trade
union, indicating that it could demand wage increases of up to 8%. Data this
week is limited to EU-15 industrial production, which may contract by 0.3% in
July, compared with a flat outcome in June, the third consecutive monthly fall.
This is related to the adverse impact of rising raw-material costs and the
strong euro. However, the euro's recent depreciation may have a positive impact
on Europe's manufacturing
industry in the months ahead.
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