What Is Economic Forecasting?
Economic forecasting is the process of attempting to predict the future condition of the economy using a combination of important and widely followed indicators. Economic forecasting typically tries to come up with a future gross domestic product (GDP) growth rate, involving the building of statistical models with inputs of several key variables, or indicators. Some of the primary economic indicators include inflation, interest rates, industrial production, consumer confidence, worker productivity, retail sales and unemployment rates, to name several.
Economic Forecasting Explained
Economic forecasts are geared toward predicting quarterly or annual GDP growth rates, the top level macro number upon which many businesses and governments base their decisions with respect to investments, hiring, spending, and other important policies that impact aggregate economic activity. While economic forecasting is not an exact science — in fact, it often misses the mark (economics has been labeled the "dismal science" for a reason) — managers of businesses need a quantified target to plan for future operating activities and government officials need a guide for fiscal and monetary policies.
Private sector companies may have in-house economists to focus on forecasts most pertinent to their specific businesses (e.g., a shipping company that wants to know how much of GDP growth is driven by trade) or they rely on Wall Street or academic economists, those attached to think tanks or boutique consultants. Economists employed by the Federal, state or local governments play a role in helping policymakers set spending and tax parameters. However, since politics is highly partisan, most rational people regard economic forecasts produced by governments with healthy doses of skepticism. A prime example is the long-term GDP growth forecast assumption in the U.S. Tax Cuts and Jobs Act of 2017 that projects a much smaller fiscal deficit that will burden future generations of Americans — with drastic implications to the economy — than independent economist estimates.
Many suspect that economists who work for the White House or are forced to toe the line produce unrealistic scenarios in an attempt to justify legislation. Will the inherently flawed self-serving economic forecasts by the Federal government be accurate? As with any forecast, time will tell. The challenges and subjective human behavioral aspects of economic forecasting are not limited to the government. Private sector economists, academics, and even the Federal Reserve Board have issued economic forecasts that were wildly off. Ask Alan Greenspan, Ben Bernanke or a highly compensated Wall Street or ivory tower economist what GDP forecasts they produced in 2006 for 2007-2009.