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September 1999
Economic Forecasting
and its Role in Making
Monetary Policy
Purposes of Forecasts
September 1999
September 1999
1. Reviews of international forecast accuracy include Llewellyn and Arai (1984), Artis (1988; 1996), Ballis (1989),
Barrionuevo (1992), OECD (1993) and IMF (1998). For the UK, Pain and Britton (1992) review the National
Institute forecasts, while Budd (1999) contains a fascinating account of the experience of the UKs Panel of
Independent Forecasters. Romer and Romer (1996) compared Federal Reserve forecasts with others. Early
Australian work on the topic included Pagan et al. (1982a; 1982b) and Macfarlane and Hawkins (1983).
September 1999
Graph 1
United States Real GDP Growth
%
%
Actual
2
Range
1
Consensus forecast
(mean)
-1
1991
1993
1995
1997
1999
-1
September 1999
2. The following anecdote, from a recent book by Thomas Mayer about US monetary policy in the 1960s and 1970s,
is of interest. In the early to mid 1960s, according to one Fed insider, Federal Reserve Chairman William McChesney
Martin had so little faith in economic forecasts that the staff was prohibited, on pain of being fired, from making
forecasts other than flow-of-funds forecasts and primitive GNP forecasts connected with the flow-of-funds forecasts.
And even these forecasts could not be made within the sacred premises of the Temple, but had to be made on
Sunday mornings at the home of a senior staff economist (Mayer 1999, p. 19). These days central bank staff are
at least allowed to develop their forecasts at the office!
September 1999
3. In slightly more technical language, with a linear model and a quadratic objective function, certainty equivalence
is the optimal strategy.
4. In a way, this is analogous to something which many in todays audience have something to do with as advisers,
namely funds management. A funds manager has to listen to the prognosis for a particular market or instrument.
He/she then has to ask How much am I prepared to stake on this view? and How much will I regret it if I take a
position and turn out to be wrong?.
Decision-making under
Uncertainty
September 1999
5. Having said that, Budd showed how people with diametrically opposed views on how the economy worked could
sometimes come up with the same advice on policies! This almost turns the old joke about economists on its head.
September 1999
Conclusion
September 1999
References
Artis, Michael J (1988), How Accurate is the
World Economic Outlook? A Post-Mortem on
Short-Term Forecasting at the International
Monetary Fund, Staff Studies for theWorld Economic
Outlook, IMF, July, pp. 149.
Artis, Michael J (1996), How Accurate are the
IMFs Shor t-Term Forecasts? Another
Examination of the World Economic Outlook,
International Monetary Fund Working Paper
No. 96/89.
Ballis, B (1989), A Post Mortem on OECD
Short-Term Projections from 1982 to 1987,
OECD Economics and Statistics Department
Working Paper No. 65.
Barrionuevo, Jos M (1992), A Simple
Forecasting Accuracy Criterion under Rational
Expectations: Evidence from the World Economic
Outlook and Time Series Models, International
Monetary Fund Working Paper No. 92/48.
Blinder, Alan S (1996), Central Banking in Theory
and Practice, The Lionel Robbins Lectures, MIT
Press, Cambridge, MA.
Budd, Alan (1999), Learning from the Wise
People, The Manchester School, 67(supplement),
pp. 3648.
IMF (1992), The Accuracy of World Economic
Outlook Projections for the Major Industrial
Countries, Annex VIII, World Economic Outlook,
May, pp. 8893.
Llewellyn, John and Haruhito Arai (1994),
International Aspects of Forecasting Accuracy,
OECD Economic Studies, 63, pp. 73117.