Conditional Forecasting - Economic Forecasting - Lecture Slides, Slides of Economics

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Conditional Forecasting and Macroeconomic Models

Multiple Variable

Forecasting Models

Forecasts conditional on specific

future events

Conditional Forecasts

 Forecasting approaches that we have discussed would produce the same forecasts in either event, independent of whether such an event really would affect the economy.

 Such a depression (or its absence) is a future event and not included in the history of the economy that is input into the forecasting process

 You need to be able to form some idea as to what the current shock will be, and how its effects will spread through the system.

Conditional Forecasts

 To conduct such forecasting exercises you need a different type of framework

 Such a framework is provided by Macroeconomic or Macroeconometric Models

Examples of Exogenous

Variables

 Monetary Policy Variables:

• how will economy behave if Fed keeps the Funds rate target at present level (5.25) for rest of year vs. increasing it 50 basis points (5.75) this spring and holding at that for the rest of the year.

 Fiscal Policy Variables:

• what is the impact of a 15 % income tax reduction vs, maintaining the current rates.

Examples of Exogenous

Variables II

 World Economic Events

• Dollar is now trading at about 125 yen and 1.8 D- marks compared with 110 and 1.50 a two years ago. What are the consequences of major (permanent) changes in exchange rates for U.S. economy? for foreign economies?
• World Crude Oil Prices dropped substantially with reduced demand from SE Asia, then rebounded. What are the implications for the U.S. economy if such price decreases are repeated?

Sources of Economic

Forecasts I

 Building your own wheel

 Borrowing someone else’s wheel

• lots of publicly available forecasts at present.
• Congressional Budget office prepares forecasts semi- annually (typically two year horizon)
• Council of Economic Advisers prepares annual forecast (two year horizon)
• FED publishes estimate of “central tendencies”

Sources of Economic

Forecasts II

 Private Forecasts - publicly available

• Wall Street Journal publishes forecasts from a sample of economists semiannually.
• University of Michigan forecast summary available: » http://rsqe.econ.lsa.umich.edu/forecast/table.html
• Survey of Professional Forecasters (Philly FED) » http://www.phil.frb.org/econ/spf/spfpage.html
• “Livingston Survey” of Economists (Philly FED) » http://www.phil.frb.org/econ/liv/welcome.htmldocsity.com

Combining Forecasts

 Large technical literature on how to best combine forecasts to minimize forecast error variance.

• problem is similar to constructing a minimum variance asset portfolio (except you can sell a forecaster who is consistently wrong short -- negative weight)
• difficulty is in getting long enough individual forecasting record to get any precision on the optimal weights of individual forecasters
• typically people just construct a simple average

Macroeconomic Models

A. Basic Structure

Measuring Investment

Demand

 Investment as used in should not be confused with Investments as used in finance

• Investment here refers to purchases of newly produced plants and equipment (including houses) plus changes in stocks of inventories (+/-) held by firms

Investment Demand

 Simple Investment Function - Investment depends negatively on real interest rates.

• theory is that at lower real interest rates there are more profitable opportunities for firms to exploit
• Problems » accurately measuring real interest rates = nominal interest rates - expected future inflation » Investment a very volatile component of real GDP » Lags between initiation of project and completion

Estimated Annual Long-

Term Real Rate

Estimated Real Interest Rate

-15 30 37 44 51 58 65 72 79 86 93

- -

0

5

10

15

Investment and Real Interest

Rates

Investment Ratio and Real Interest Rate

realrate

-15 -10 -5 0 5 10 15