The interpretation and use of economic predictions

Abstract

Treasury forecasts, both published and unpublished, of GDP and retail prices are analysed with reference to average absolute forecast errors and a benchmark index of variation. Forecasts of both GDP and the RPI looking two years ahead have become more accurate since the early 1970s, but there has been no marked improvement in one year ahead forecasts. The accuracy of annualized forecasts of GDP improves, and that of the RPI forecasts deteriorates, as the forecast time horizon is progressively extended from one to eight quarters ahead. Some evidence of forecast bias is presented ; in the period up to 1979, GDP tended to be over-predicted, and inflation under-predicted. Since 1980 this pattern has been reversed. Analysis of Treasury forecasts and an average of U. S. forecasts shows them to be about equally accurate. The role of forecasts in the implementation of economic policy is discussed. Systematic model-based forecasts provide a consistent framework of analysis, which can improve the operation of economic policy. But prediction errors, and the inertia of the economy, imply that there is only limited scope for discretionary, forecast-based, stabilization policy. Under the medium term financial strategy, MTFS, the policy emphasis has shifted to the medium term. The forecasts have been used to articulate assumptions for output, inflation and money GDP, and to provide the tax and expenditure framework behind the illustrative path of the PSBR. Without the forecasts, the conduct of monetary and fiscal policy would have been considerably more difficult. The paper concludes that, while reductions in the forecast errors of short-term forecasts may be difficult to achieve, there is hope that the accuracy of longer-term forecasts may continue to improve.