An economic forecast is a prediction of future economic activity, usually for one or more broad categories such as employment, income, price inflation and output. Economic forecasts may also include specific factors for a particular industry or firm such as sales, profits or capital investments. Forecasts are typically prepared annually but many are updated more frequently.
There are a variety of methods used for economic forecasting, with some relying on the statistical time-series method and others on more complex econometric models. The latter approach is often used by central banks.
Despite its popularity, time-series analysis has its limitations. The fact that it is based on the regular behavior of the variables under study means that changes in policy or other exogenous events can disrupt the relationship between past data and future performance. This is known as the Lucas critique and led to the development of vector autoregressive (VAR) and dynamic stochastic general equilibrium (DSGE) models.
The most common measure of output is Gross Domestic Product (GDP), which is defined as the monetary value of all finished goods and services produced within an economy’s borders. Other economic measures, such as gross national product (GNP) and inflation, are derived from GDP.
It is notoriously difficult to predict the future and economic forecasts are subject to a wide range of errors. A major cause of this is the subjective nature of the process, with projections heavily influenced by an economist’s own theory about how the economy works. For example, if an economist believes that business activity is determined by the supply of money, they are likely to pay more attention to monetary indicators when making their projections. This can lead to biased or skewed projections.