Students should not only focus on the trend of the growth rate but understand the strict relationships between the trends of different economic variables and between different countries. A macroeconomic forecast would include the following steps:
i) A brief introductory economic and political outlook for the country under consideration.
ii) The past trend of economic activity should be examined in conjunction with a selection of other variables. Growth rate of the economy, inflation rate, official discount rate, public deficit, public debt, industrial production, cost of labour, exchange rates are the most relevant. To be more accurate also the trend of the relevant variables in other countries should be analysed. For example a change in the German interest rate is likely to affect the interest rate in other European countries and therefore it should be taken into account if students analyse, for instance, the French economy.
iii) A graphical representation of the trends might help in the process of scanning regularities and links between variables in a more convenient way. A graph for each cycle should be obtained: looking at the whole time series for each variable, points of similarity and contrast between cycles can be highlighted. Looking at more variables together, can give additional insight on how the variables are linked and help the forecaster in answering the following questions: when will the variable change? By how much will it change?
iv). At this stage, statistical and econometric models are used to enlighten the future trend of the relevant variables.
Forecasting is really a difficult task and the links between variables can be more complex to predict than the simple evidence of few graphs might suggest. To judge when a variable has bottomed out or peaked and starts to change sign is particularly difficult.
A firm has a wide range of uses for forecasts. The future growth rate and the future level of economic activity are important to predict the level of demand and therefore its own sales and profits. Profits are also linked to expected inflation. Inflation itself and the interest rate are important to determine the expected cost of a planned investment which, however, depends also on the future level of aggregate demand. Forecasts about other countries' level of activity and exchange rate are important to determine the costs of production (if inputs are imported) and future profits (if output is exported).
Q2 A stockbroking firm provides your business with a quarterly review containing forecasts of GNP growth for one, two and three years ahead. You are asked to evaluate the forecasting record of this firm. How would you propose doing this?
We know that forecasting is a very difficult task and that forecasters are more likely to be wrong that to be right. That said, some forecasters are less wrong than others. How to judge them? The best manner is to compare past forecasts with real figures and use the root mean square error