Aug

5

V N In evaluating economic forecasts, one should consider the null hypothesis, which is Milton Friedman's, that the expected change in GNP next quarter, adjusted for part/whole effects and overlaps, is a constant 3% a year, regardless of the previous conditions.

John De Palma replies:

GDP forecasts of Wall Street economists and the Fed improve only a bit on "naive, same change" predictions (i.e. predictions that "future growth rate will be the same as the most recently observed growth rate"). Former St. Louis Fed President William Poole summarized research on forecast accuracy as part of a February 2004 speech:

"(…)The authors compared the Blue Chip forecasts, the Greenbook forecasts, and the FOMC members' forecasts against a naive, same change, forecast beginning in 1980 for both real output growth and inflation. Three different forecasting horizons were examined: six, twelve and eighteen months. Not surprisingly, the accuracy of the forecasts deteriorates as the forecasting horizon is lengthened. For a one-year-ahead forecast, the root-mean-squared forecast error (a measure of the dispersion of the forecasts around the realized value) for real output growth is on the order of 1.4 percentage points for all three sets of forecasts considered. The root-mean-squared forecast error for the naive constant change forecast is considerably larger, on the order of 2.2 percentage points.

Clearly, the forecast accuracy of the forecasters is substantially better than that of the naive forecast, but still leaves a lot of room for surprises. To make this point clear in today's context, if for convenience we say that the GDP growth forecast is 4½ percent over the four quarters ending 2004:Q4, then one standard error leaves us with a forecast band of 3 - 6 percent growth over this period. If we were to have a 3 percent outcome, everyone would fear that the recovery is faltering; if we were to have a 6 percent outcome, the most likely characterization would be that we have a boom on our hands(…)"


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