What is Economic Forecasting and Methods of Economic Forecasting.

What is Economic Forecasting in simple words?

Economic forecasting is the process of trying to guess the future of economic states by combining a number of key and frequently studied data.


What is Economic Forecasting and How Does It Work?

Economic forecasting is the art of predicting any feature of economic activity. Forecasts may be produced in considerable detail or in broad strokes. In any event, they assist to form the foundation of planning by describing the anticipated future behavior of the economy as a whole or in part.


What is Economic Forecasting, Economic forecasting, History of Economic Forecasting, Economic Forecasting Methods
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Economic forecasting is the creation of statistical models based on the inputs of a number of important factors or indicators, with the goal of predicting future Gross Domestic Product (GDP) growth rates.


 Inflation, interest rates, factory output, consumer confidence, productivity increases, retail sales, and unemployment rates are all important economic indicators.


Formal economic forecasting is typically based on a theory of how the economy operates. Some ideas are complex, and applying them requires an in-depth analysis of cause and effect. Others are more straightforward, attributing most economic changes to one or two fundamental causes. 


For example, many economists think that changes in the money supply influence the pace of growth of overall economic activity. Others place a great value on new infrastructure—housing, industrial plants, roads, and so forth. 


Some economists think that consumer choices to invest or save offer the most important indications to the future path of the whole economy in the United States since consumers account for such a significant proportion of economic activity. 


Obviously, the theory that a forecaster employs is essential to the forecasting process; it defines his path of inquiry, the statistics that he will consider most significant, and many of the data that he will use.


Although the economic theory may help to shape the basic framework of a prediction, judgment is often used as well. A forecaster may determine that the present conditions are unique and that a forecast generated using traditional statistical techniques should be adjusted to account for them. 


What is Economic Forecasting, Economic forecasting, History of Economic Forecasting, Economic Forecasting Methods
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This is especially important when an incident that occurs outside of the normal course of business has an economic impact. Forecasts of economic activity in the U.S., for example, were more correct in 1987 when the analyst correctly anticipated that the value of the dollar would decrease substantially during the year. the year, that consumer spending would slow, and that interest rates would only increase modestly. 


None of these conclusions were reached only on the basis of economic analysis; they all required judgment about future choices. 


Similarly, an economist may opt to modify a conventional economic prediction to account for additional specific variables; for example, he may determine that consumers would change their spending habits due to unusual circumstances such as increasing import costs or the possibility of shortages.


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The Process of Economic Forecasting

Economic forecasts aim to estimate quarterly or yearly GDP growth rates, the top-level macro statistic that many companies and governments use to make choices about investments, hiring, spending, and other key policies that affect aggregate economic activity.


Economic predictions are used by business management as a reference to plan future operational operations. Companies in the private sector may have in-house economists who concentrate on predictions that are most relevant to their operations (e.g., a shipping company that wants to know how much of GDP growth is driven by trade.) They may also turn to Wall Street or university economists, think tank economists, or boutique consultants.


Understanding the future is also essential for government officials since it helps them decide which public finances to adopt. Economists working for the federal, state, or municipal governments play an important role in assisting politicians in deciding spending and tax plans.


Because politics is so divided, many reasonable people view government economic predictions with a good dosage of doubt. The long-term GDP growth projection assumption in the United States Tax Cuts and Jobs Act of 2017 is a good example since it forecasts a significantly lower fiscal deficit that would burden future generations of Americans with severe economic implications than independent expert estimates.


Who Will Prepare Economic Forecasting

Governments banks as well as central banks, analysts, and private industry agencies such as think tanks, industries, and international organizations such as the International Financial Institutions, the World Bank, and the Organization for Economic Co-Operation are all involved in economic forecasting (OECD). Many predictions are made yearly, but many are revised more regularly.


History of Economic Forecasting

Forecasting the economy has been practiced for centuries. The Great Depression of the 1930s, on the other hand, was responsible for the current levels of analysis.


Following that tragedy, a greater emphasis was put on knowing how the economy functions and where it is headed. So,  a wider range of statistics and analytical methods has emerged.


Limitations of Economic Forecasting

Forecasting the economy is often considered poor science. Many people believe that White House economists are compelled to toe the line, creating false scenarios in order to support the legislation. 


Will the federal government's fundamentally faulty self-serving economic predictions be accurate? Time will tell, as with any prediction.


Economic forecasting has its own set of difficulties and subjective human behavioral elements that are not exclusive to the government. 


Economic predictions by private-sector economists, academia, and even the Federal Reserve Board (FSB) have all been far off the mark. 


Inquire of Alan Greenspan, Ben Bernanke, or a well-paid Wall Street or ivory tower economist what GDP projections they made in 2006 for the time of the Great Recession, which lasted from 2007 to 2009.


Economic forecasters have a track record of failing to predict catastrophes. Economists have failed to forecast 148 of the last 150 recessions, according to Prakash Loungani, assistant director and senior personnel and budget manager at the International Monetary Fund (IMF).


This failure to predict impending downturns, according to Loungani, reflects the demands on forecasters to be conservative. Many people, he said, prefer not to deviate from the mainstream because they are afraid of damaging their reputation and perhaps losing their employment if they do.


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Methods of Economic Forecasting


What is Economic Forecasting, Economic forecasting, History of Economic Forecasting, Economic Forecasting Methods
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Some of the Economic Forecasting Methods are as follows

1. Causal (Multivariate) Forecasting Methods: Regression methods

Make future projections by modeling the causal relationship between one series and another. Forecasting can be done using time series or cross-sectional data.

Yt = f (Xt)

or

 Yt = f (X1t, .., Xkt, Y2t, .., Y1k)

Methods: Simple or Multiple models

 System equation models

 Seeming unrelated models


2. Univariate forecasting methods or Time series methods

Using the past, internal patterns in data to forecast the future.

Yt+1 = f (Yt, Yt-1, Yt-2, Yt-3)

 Methods: Moving average

 Smoothing and Exponential smoothing

 Decomposition: Seasonal and trend decomposition

 ARIMA (box-Jenkins)


3. Multivariate Time series methods

Y1t = f (Y1,t-1, .., Y2,t, …,Yj,t, .., X1,t,…, Xj,t-k)

Methods: Multivariate ARIMA models

Autoregressive and distributed-lag models

 Vector Autoregression (VAR)

Vector Error Correction (VEC) models

 ARCH and GARCH models


4. Qualitative Forecasting Methods:


Dummy variables are used to describe the data that decisions are based on. involved. Qualitative data is a term used to describe this kind of information. Models such as Dependent variables of the yes-no kind are referred to as dichotomous or dummy dependent variables.


Models with variable regression variables There are three methods for estimating and forecasting.

1. Linear Probability Model (LPM)

2. Logit Model

3. Probit model and Tobit model. 


Other qualitative forecasting techniques rely on people's judgment and views. others, such as future trends, preferences, and technical advancements.


Delphi, market research, panel consensus, and scenario development are examples of qualitative techniques.


Future prediction techniques include analysis and historical analogies. Qualitative when there isn't enough data to justify quantitative techniques, methods are helpful.

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