General Methodology

The task was to nowcast the growth rate of the Portuguese GDP in the 3rd Quarter of 2014
(2014Q3). The term nowcasting refers to an approach by which events or activities of the very
recent past or presence, that have themselves not been fully captured or reported, are measured
using related and available high-frequency data. In the following report, the terms forecasting and
predicting, despite their marginally different meaning, will be used in addition to nowcasting. In
this particular case, we, firstly, used monthly-reported economic indicators, that are directly related
to components of the GDP, namely private consumption and investment, in order to make viable
predictions about the respective account. Secondly, we examined already published numbers for
government expenditure for the three months of the third quarter and added these up to determine
public consumption for 2014Q3. Thirdly, we looked into the current economic performance of
Portugals main trading partners, namely Germany, France and Spain, to gauge foreign demand and
hence predict export numbers. Lastly, we examined the relation between internal demand and
imports and predicted a value of these account for 2014Q3. Combining the resulting numbers for
private consumption, public consumption, investment and net-exports we obtained a prediction for
the Portuguese GDP for the third quarter of 2014. Data from Banco de Portugal, INE, OECD, Eurostat
and Direo-Geral do Oramento were included. For a more detailed overview of the data used, see
folder entitled data. If particular time series are missing,

Predicting Private Consumption: Methodology, Economic Reasoning and Results

The component of private consumption can be divided into two main parts: durables and nondurables. Durables are consumer products that are designed to last and are thus less frequently
purchased by consumers. Examples include furniture, cars and electronic devices. We used the sales
number of passenger vehicles as a proxy as this figure is directly linked to the final figure for durables
as it enters the final GDP accounts. In addition to that we included two confidence indicators in our
analysis: retail confidence indicator and consumer confidence indicator. The indicator of consumer
confidence can be assumed to have predictive power for private consumption since the current
consumer behavior is a function of the current economic sentiment as well as the economic outlook
of consumers. These two aspects are subject of the consumer confidence measurement. Similarly,
the current economic sentiment and the economic outlook of retailers are linked to current sales
numbers of these economic agents. These proxies are relevant to both the sectors - durables and
non-durables. To determine the overall statistical relation between private consumption and the
mentioned proxies we ran an OLS-regression, in which we also included yearly dummy variables to
account for the overall economic trend. For an overview of the included data, please see the excel
file entitled private consumption regression data. We obtained an adjusted R-squared of 0.9659

which indicates a good overall fit of our model as it is able to explain almost all variability of the
dependent variable. For a complete overview of the results of the regression, please see the excel
sheet entitled private consumption forecast. Using the results of the regression in conjunction with
the latest data on the used proxies, we obtained a prediction of 27448.71 Mio for the private
consumption of 2014Q3. Comparing this figure to 27108.1 Mio from the same period of the
previous year (2013Q3), results in a y-o-y growth rate of 1.26%.

Predicting Investment: Methodology, Economic Reasoning and Results

The account of investment as it enters the GDP is generally composed of the components
construction, transport material and machinery. In order to make substantiated predictions about
these aspects we used cement sales, sales of commercial vehicles (light and heavy) and the industrial
confidence indicator as our proxy variables. Cement sales are assumed to be directly correlated with
the sector of construction since cement is universally used in the vast majority of construction
projects. Moreover, the fact that cement has to be used shortly after being acquired further
improves the predictive properties of cement sales and reduces lag in regards to the construction
account. Sales of commercial vehicles are an appropriate proxy for transport materials as they
constitute a substantial part of this component. Furthermore, we chose the industrial confidence
indicator as one of our explanatory variables because the evaluation of the current economic
situation and the economic outlook by firms are determinant of the form and magnitude of their
investment. To determine the overall statistical relation between investment and the mentioned
proxies we ran an OLS-regression, in which we also included yearly dummy variables to account for
the overall economic trend. For an overview of the included data, please see the excel file entitled
Investment regression data We obtained an adjusted R-squared of 0.9628 which indicates a good
overall fit of our model as it is able to explain almost all variability of the dependent variable. For a
complete overview of the results of the regression, please see the excel sheet entitled forecast
summary Investment. Using the results of the regression in conjunction with the latest data on the
used proxies, we obtained a prediction of 6317.622632 Mio for the Investment of 2014Q3.
Comparing this figure to 6808.9 Mio from the same period of the previous year (2013Q3), results in
a negative y-o-y growth rate of 7.22%.

Predicting Government Consumption: Methodology, Economic Reasoning and Results

Different to the above mentioned components of the GDP, namely private consumption and
investment, the government consumption of the third Quarter of 2014 has already been reported by
the Portuguese authorities. The published data merely lacks a finalized account for the quarter but
figures for the three relevant months, July, August and September, have been (implicitly) published.

We obtained our figure by subtracting the accumulated expenditure (compensation of government

employees, purchases of goods and services, and capital investment) as of June from the same
account as of September (respective periods of accumulation start in January), which resulted in
8,284.8 Mio. .
The reported numbers are given in current prices. In order to obtain the figure in real terms, the
reported number had to be deflated appropriately. We determined the deflator by comparing
nominal and real quarterly government consumption figures up to 2014Q2 (see excel file entitled GDeflator). Through this approach we obtained a deflator of 0.9903 for 2014Q2 (base=2011). For the
lack of a better alternative, we assumed that this figure is the same for 2014Q3. Deflating the
nominal number results in a real figure of 8,366.0 Mio. . Comparing this number with the figure of
8,162.0 Mio. of the same period of the previous year gives us a predicted y-o-y growth rate of 2.5%
for government consumption.

Predicting Net-Exports: Methodology, Economic Reasoning and Results

The figure for Net-exports constitutes the differential of exports and imports. Hence, it is a viable
strategy to form predictions about these separate accounts first and then adding them up to obtain
the net-export figure.
In our model we assumed that exports are primarily a function of external demand. External Demand
is directly linked to the GDP growth rate of the main trading partners. In case of Portugal, the main
trading partners are Germany, France and Spain. We included the respective quarterly growth rate of
these countries as proxy variables for external demand in our model. For the third quarter of 2014
we included the OECD forecasts (made in May 2014) for quarterly growth of these countries. Please
note that this approach to exports is not applicable to other countries without reservations, since
price (domestic vs. foreign prices) and (nominal) exchange rate effects are significant for countries
that trade primarily with countries with different currencies. In the case of Portugal, however, these
effects seem negligible since most trading partners are within the Eurozone. In our regression for
exports we included the growth trade of the main trading partners alongside with yearly dummy
variables as the explanatory variables. See excel file entitled export regression data for an overview
of the included data. We obtained an adjusted R-squared of 0.9882 with indicates a near-perfect
statistical fit of our model. For a complete overview of the results of the regression, please see the
excel sheet entitled forecast summary exports. Using the results of the regression in conjunction
with the forecasted growth rates of the trading partners, we obtained a prediction of 17160.47583
Mio for the Exports of 2014Q3. Comparing this figure to 16650.6 Mio from the same period of the
previous year (2013Q3), results in a y-o-y growth rate of 3.06%.

Further, we based our model on the assumption that imports are primarily a function of domestic
demand, namely private consumption, investment and government consumption. We ignored
possible substitution effects between importing foreign products and consuming domestic products
because variations of real exchange rates can be assumed to be small within the Eurozone. Thus, we
ran a regression using previous data of these components and yearly dummy variables as
explanatory variables for the magnitude of imports. See excel file entitled import regression data
for an overview of the included data. We obtained an adjusted R-squared of 0.992 with indicates a
near-perfect statistical fit of our model. For a complete overview of the results of the regression,
please see the excel sheet entitled forecast summary imports. Using the results of the regression in
conjunction with the forecasted figures1 for private consumption, government consumption and
Investments, we obtained a prediction of 16821.3 Mio for the imports of 2014Q3. Comparing this
figure to 16773.1 Mio from the same period of the previous year (2013Q3), results in a y-o-y
growth rate of 0.29%.
Combining the results for exports and imports we obtain a value for net-exports of 339.2 Mio. in
2014Q3, whilst the net-export account in 2013Q3 was negative at -122.5 Mio. .

Forecasting GDP
In order to obtain an estimate for the overall GDP growth rate we combined the results for each
account and added them up. In doing so, we obtained a quarterly GDP for the third quarter of 2014
of 42471.5 Mio. . The GDP of the same period of the previous year was 41956.5 Mio. . This results
in a forecasted year-on-year real growth rate of 1.23%.

Limitations of Forecast Methods

Generally speaking, the value of the nowcast-method as applied in this work is questionable. The
actual data that the final GDP account will be based on can be assumed to be already captured (at
least to a sufficient degree) at the point in time, at which high-frequency proxy data available to the
general public allows to make a nowcast. This means that nowcasting is a mere attempt to close
the temporary information gap between reporting authorities and the general public. Put differently,
it can be assumed that the Banco de Portugal at this point already has captured more conclusive (if
not fully comprehensive) data for the GDP of 2014Q3. Having said that, in todays information driven
financial markets closing this narrow information gap through a precise nowcast can put an
economic agent at a substantial advantage over a less informed counter party.

Values based on our own forecast

There are further limitations that are specific to our model. We predicted imports based on our own
predictions of the components of internal demand, namely private consumption, public consumption
and Investment. This constitutes a problem since the effect of inaccuracies in the predictions of
internal demand will be further exacerbated by their influence on import predictions.
Moreover, the regression for exports assigned great importance to the growth rate (indicated by high
values for respective coefficients) of the trading partners GDP. This is in line with our economic
reasoning but also leads to great volatility of the export prediction. For example, the forecasted GDP
growth rate for Germany in 2014Q3 has been repeatedly adjusted since the OECD forecast in May
(1.9%) which was included in our model. A change of 1% in forecasted GDP growth of France,
Germany and Spain corresponds to a change in our predictions of 175.5 Mio (France), 22.2 Mio.
(Germany), and 252.2 Mio. (Spain), respectively. This highlights to high degree to which our
predictions are subject to potential inaccuracies of officially issued growth forecasts.
Furthermore, the selection of explanatory variables as used in our model, despite being based on
well-founded economic reasoning, is to some extend haphazard. For some explanatory variables
there exist other viable options that could have been included in the model. Inclusion of these may
lead to different overall results. Hence, it is important to examine potential interests that are not in
line with conducting a purely objective nowcast. In our case, we could have been motivated to
include variables that lead to a smooth prediction that fits the overall time series of GDP growth.