CAU Kiel Applied Business Cycle Analysis and Forecasting

Lecture: Applied Business Cycle Analysis and Forecasting

Chapter 1
Forecasting what and for whom?

SoSe 2015 Lecture

CAU Kiel Applied Business Cycle Analysis and Forecasting

Forecasts are always wrong!

As long as we perceive the “reality” as realization of a stochastic

process (where errors have continuous support) it is hard to strike
the exact figure!

Precision of forecasts is sometimes not just a matter of “good”

forecasting methods but of error volatilities.

No solution to the problem that forecasts are “wrong” in sight.

Reporting uncertainty can be helpful. Forecasts are needed anyway.

SoSe 2015 Lecture

CAU Kiel Applied Business Cycle Analysis and Forecasting

Forecasting: tool for decision making

The sentence in a trial depends on the probability that the

convicted gets delinquent again.

Your decision to start an education program depends on the

outlook for later job opportunities in this profession.

Recently, private operators of Spanish highways got bankrupt.

They had projected a steep increase in traffic (before the crisis)
and provided excess capacities.

SoSe 2015 Lecture

CAU Kiel Applied Business Cycle Analysis and Forecasting

Business cycle stabilization and forecasting

Classic idea of Keynesian economics: monetary policy or fiscal

policy intervene to prevent business cycle downswings.

However, where is the Business Cycle at the moment (less trivial

question than you may think)?

Where will it be in a few month?

A necessary condition for successful stabilization policies is “good”

forecasting.

SoSe 2015 Lecture

CAU Kiel Applied Business Cycle Analysis and Forecasting

(Modern) Macroeconomics and forecasting

Example: Clarida, Gali und Gertler (2000) specify a reaction

function for monetary policy. Given that monetary policy has
foresight of one year it takes the form

rt∗ = r ∗ + β(E (πt+1 |Ωt ) − π ∗ ) + γE (xt+1 |Ωt ),

where rt∗ denotes the response of monetary policy according to this

rule. r ∗ and π ∗ denote equilibrium values for interest rates and
inflation. These values are assumed to be known. πt+1 denotes
inflation in the next period and xt+1 output gap in the next period.
Ωt denotes the information set available in t.

If central banks want to use these kind of concepts they need

“foresight”.

SoSe 2015 Lecture

CAU Kiel Applied Business Cycle Analysis and Forecasting

Fiscal policy and forecasting

Beyond stabilization policies forecasting is also important in fiscal

policy to do planing (tax projections) and to evaluate the current
stance of fiscal policy. This is especially important when the
concept of structural budget balance is applied.

Further, forecasts are needed for budget planing in the short and
medium term. Compare the stability and convergence programmes:
http://ec.europa.eu/economy_finance/economic_
governance/sgp/convergence/index_en.htm

Forecasts also play a central role in debt sustainability analyses.

SoSe 2015 Lecture

CAU Kiel Applied Business Cycle Analysis and Forecasting

Example: recent forecasts of the ECB

http://www.ecb.europa.eu/pub/projections/html/index.
en.html

SoSe 2015 Lecture

CAU Kiel Applied Business Cycle Analysis and Forecasting

SoSe 2015 Lecture

CAU Kiel Applied Business Cycle Analysis and Forecasting

SoSe 2015 Lecture

CAU Kiel Applied Business Cycle Analysis and Forecasting

SoSe 2015 Lecture

CAU Kiel Applied Business Cycle Analysis and Forecasting

SoSe 2015 Lecture

CAU Kiel Applied Business Cycle Analysis and Forecasting

Some forecasters
The ECB is also interested in the view of other forecasters (survey
of professional forecasters)

http://www.ecb.europa.eu/stats/prices/indic/forecast/
html/index.en.html

Forecasts of the IMF

http://www.imf.org/external/ns/cs.aspx?id=29

Forecasts of the European Commission

http://ec.europa.eu/economy_finance/eu/forecasts/
index_en.htm

Forecasts of the OECD

http://www.oecd.org/eco/economicoutlook.htm

SoSe 2015 Lecture

CAU Kiel Applied Business Cycle Analysis and Forecasting

Forecasting and econometrics

In general, econometrics shall provide tools for decision making:
you form a stochastic model that shall fit the “reality”, estimate
the model, and draw conclusions from the model about the
“reality”.

In Econometrics I you look for marginal effects. The typical

question is whether a certain policy/actions is useful or not.

In forecasting you typically do ask about future conditions

(effectiveness of policy/actions are not relevant). This is relevant
as long as the outcome of your actions depend on future
conditions.

In forecasting models the issue of endogeneity typically does not

matter.

SoSe 2015 Lecture

CAU Kiel Applied Business Cycle Analysis and Forecasting

Business cycles, circular flow of income, and national

accounts
I Business cycle analysis until 1930s
I Tracking fluctuations in a bunch of variables
I Prices for commodities, unemployment, retail sales, etc.
I Example: W.C. Mitchell (1913)
https://archive.org/details/cu31924003462680
I Variables are interconnected: circular flow of income
I Quesnay (1758): Tableau économique
I http:
//en.wikipedia.org/wiki/Circular_flow_of_income
I National accounts: consistent system of variables based on
the circular flow of income
I National accounts were introduced in the 1920s/30s and
GNP/GDP in the 1940s.
I Nobel laureates who worked on national accounts: Kuznets
and Stone
SoSe 2015 Lecture
CAU Kiel Applied Business Cycle Analysis and Forecasting

Business cycles, circular flow of income, and national

accounts

Forecasting GDP and its components has a conceptual dimension

and a practical!
I Conceptually, forecasting of a system of variables can improve
consistency and plausibility.
I Practically, some receivers of forecasts need disaggregated
information. E.g. for tax projections not just GDP, but figures
about employment, wages, private consumption, and profits
are relevant
I Issues will be discussed in more depth when we talk about
judgemental forecasting.

SoSe 2015 Lecture