Real-Time Forecasts for the World Economy:A Practitioner's Perspective

Robin Koepke and Emre Tiftik

Global Macroeconomic Analysis DepartmentInstitute of International Finance

George Washington UniversityWashington, DCApril 26, 2012

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3 Key Messages about our Forecasts

1. We use few models and lots of judgment.

2. Knowing the data is key.

3. Forecasts are more than just numbers.

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Our Work

1. We produce a monthly “World Economic Framework” with forecasts for all major global macro variables

2. Forecasts include G3 growth, inflation, unemployment, policy interest rates etc.

3. We have a small team of 4-5 people, who devote about 20-30% of their time to the forecasts

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What’s the Purpose?

1. Express a view

2. Provide an anchor

3. Tell stories

4. Be right ("forecast accuracy")

1. Find “truth”: understand & establish the relationships between variables

2. …?

Academic Forecasts Practitioner Forecasts

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Where’s the Model?

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Where’s the Model?

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2012 2013 2014 2015 2016

January 2012 April 2012

Appropriate Time of First Policy Rate Hike as per FOMC

Number of FOMC participants in favor of time shown on x-axis

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Then How Do We do Forecasts?

1. Short term (0-6 months): tracking data

2. Medium term (3-12 months): reconcile ST changes with LT view

3. Long term (6-24 months): adopt a view

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Why Use Judgmental Forecasts? (1)

1. Judgmental forecasts can use information that is hard to quantify

2. Do you really trust your model? (I only trust it if I like the result.)

3. Stories matter!

4. Consistency matters

5. Time is scarce

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Using Judgment: “Known Unknowns”

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Current Law:Change in Deficit

Current Law:Impact on GDP

IIF Baseline:Change in Deficit

IIF Baseline: Impacton GDP

United States: Fiscal Policy in 2013

Percent of GDP, calendar year basis

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Our Current U.S. Growth Forecast

Contributions to growth in percentage points, saar

United States: Real GDP

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12 Q1 12 Q2 12 Q3 12 Q4 13 Q1 13 Q2 13 Q3 13 Q4

Net exports

Domestic final sales

Total

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Using Judgment: “Unknown Unknowns”

Index, February 2011 = 100

Japan: Industrial Production and Real Exports

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Mar 10 May 10 Jul 10 Sep 10 Nov 10 Jan 11 Mar 11

Exports IP

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Why Not Use a Model? (1)

1. Last week’s presentation: oil price forecasts have predictive power for GDP growth forecasts

2. Benchmark model: AR(4) model of GDP

3. But: if 2008 crisis is excluded, forecast does not outperform benchmark model any more

4. In October 2008, I did not need an oil price forecast to tell me we were heading into recession

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Why Not Use a Model? (2)

1. The more general point is: benchmark models pretend that we know less than we actually do

2. The fact that a candidate variable outperforms the benchmark is too low a threshold

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A Case Study: JAPAN

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A Case Study: JAPAN

percent change over previous period, seasonally adjusted, at an annual rate, unless otherwise stated              

                          Q4/Q4

      2010 2011 2012 2013 11Q3 11Q4 12Q1 12Q2 12Q3 12Q4   2011 2012 2013

Real GDP 4.5 -0.7 2.2 1.5 7.1 -0.7 3.5 2.0 1.5 1.5   -0.6 2.1 1.5

  Consumption 2.6 0.0 2.0 0.4 4.2 1.4 3.5 0.8 0.8 0.0   0.6 1.3 0.4

  Government Spending 2.1 2.1 1.2 1.0 1.1 1.5 1.0 1.0 1.0 1.0   1.9 1.0 1.0

  Fixed investment -0.1 0.6 3.4 2.1 1.7 10.3 1.1 2.3 1.8 1.8   3.3 1.8 2.3

    Business 0.8 1.0 5.1 3.2 1.2 20.7 1.0 3.0 3.0 3.0   4.5 2.5 3.5

    Government -0.2 -3.2 -1.2 -1.1 -6.1 -8.4 0.0 0.0 -2.0 -1.0   0.2 -0.8 -1.0

    Residential -4.6 5.1 2.4 1.5 19.1 -2.7 3.0 2.0 2.0 0.0   2.9 1.7 1.5

  Change in Inventories (¥ trillion, chained)

-1.3 -3.6 -2.6 1.1 -2.6 -4.1 -3.8 -2.9 -2.4 -1.3   — — —

  Exports of Goods and Services 24.4 0.0 1.7 2.4 38.9 -11.8 2.0 3.0 3.0 3.0   -1.6 2.7 2.0

  Imports of Goods and Services 11.1 5.8 2.7 2.9 14.1 4.3 -3.0 2.0 3.0 3.0   5.8 1.2 2.7

Contribution to Changes in Real GDP:                              Domestic final sales 2.0 0.5 2.1 0.8 3.1 3.1 2.5 1.1 1.0 0.5   — — —

  Net Exports 2.0 -0.7 -0.1 0.0 3.6 -2.6 0.8 0.2 0.1 0.1   — — —

  Inventories 0.7 -0.4 0.2 0.7 0.8 -1.2 0.3 0.7 0.4 0.9   — — —

  Discrepancy -0.2 -0.1 — — -0.4 0.0 — — — —   — — —

Index of Manufacturing Production 16.6 -2.3 8.1 5.2 24.0 2.2 15.0 8.0 5.0 5.0   0.0 8.2 5.0

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Current-year Forecasts: (current state of macroeconomic foresight)

Short term: next 0-6 months Medium term: next 3-12 months

Now-cast: previous 3 months

Year-ahead ForecastsLong term: next 6-24 months

How far Ahead Can We Forecast?

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Terminology and Concepts

1. Know your data

• Time of data releases• weekly/monthly/quarterly

• REVISIONS

• Seasonally Adj?

• Real vs nominal magnitudes

• Calculating annual changes• oya vs y/y vs q4/q4• Smoothing (3mma)• Extrapolating annualized

quarterly rates from monthly data

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Apr09

Aug09

Dec09

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Dec10

Apr11

Aug11

Dec11

First Preminary

Second Preliminary

Final - with two-year lag

Real GDP Releases

Percent change, q/q, saar

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percent change over previous period, seasonally adjusted, at an annual rate, unless otherwise stated              

                          Q4/Q4

      2010 2011 2012 2013 11Q3 11Q4 12Q1 12Q2 12Q3 12Q4   2011 2012 2013

Real GDP 4.5 -0.7 2.2 1.5 7.1 -0.7 3.5 2.0 1.5 1.5   -0.6 2.1 1.5

  Consumption 2.6 0.0 2.0 0.4 4.2 1.4 3.5 0.8 0.8 0.0   0.6 1.3 0.4

  Government Spending 2.1 2.1 1.2 1.0 1.1 1.5 1.0 1.0 1.0 1.0   1.9 1.0 1.0

  Fixed investment -0.1 0.6 3.4 2.1 1.7 10.3 1.1 2.3 1.8 1.8   3.3 1.8 2.3

    Business 0.8 1.0 5.1 3.2 1.2 20.7 1.0 3.0 3.0 3.0   4.5 2.5 3.5

    Government -0.2 -3.2 -1.2 -1.1 -6.1 -8.4 0.0 0.0 -2.0 -1.0   0.2 -0.8 -1.0

    Residential -4.6 5.1 2.4 1.5 19.1 -2.7 3.0 2.0 2.0 0.0   2.9 1.7 1.5

  Change in Inventories (¥ trillion, chained)

-1.3 -3.6 -2.6 1.1 -2.6 -4.1 -3.8 -2.9 -2.4 -1.3   — — —

  Exports of Goods and Services 24.4 0.0 1.7 2.4 38.9 -11.8 2.0 3.0 3.0 3.0   -1.6 2.7 2.0

  Imports of Goods and Services 11.1 5.8 2.7 2.9 14.1 4.3 -3.0 2.0 3.0 3.0   5.8 1.2 2.7

Contribution to Changes in Real GDP:                              Domestic final sales 2.0 0.5 2.1 0.8 3.1 3.1 2.5 1.1 1.0 0.5   — — —

  Net Exports 2.0 -0.7 -0.1 0.0 3.6 -2.6 0.8 0.2 0.1 0.1   — — —

  Inventories 0.7 -0.4 0.2 0.7 0.8 -1.2 0.3 0.7 0.4 0.9   — — —

  Discrepancy -0.2 -0.1 — — -0.4 0.0 — — — —   — — —

Index of Manufacturing Production 16.6 -2.3 8.1 5.2 24.0 2.2 15.0 8.0 5.0 5.0   0.0 8.2 5.0

GDP = Private Consumption + Government Consumption + Fixed Investment (Business + Residential + Government) + Net Exports+ Change in Inventories

Then How Do We Make Forecasts? Forecasting with Spreadsheets

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Then How Do We Make Forecasts?

2. Information Gathering

Track Your Data

(Framework to incorporate latest releases quickly)

Japan

Tracking the Current Quarter

Q3 11 Q4 11 Q1 12 Q2 12 Data

to date through

Real GDP 7.1 -0.7 3.2 2.0

Consumption

Retail Sales 2.0 -4.1 21.7 February

Real Private Consumption 3.5 1.3 3.2 February

Auto Sales (million units, saar) 3.2 3.1 3.9 March

Consumption (constant prices, NIPA) 4.2 1.4 3.0 0.8

Investment

Machinery Orders (Domestic Private) -2.5 0.4 1.2 February

GFCF (NIPA) 1.7 10.3 1.5 2.3

Inventory Contribution to Growth (% points) 0.8 -1.2 0.2 0.7

Trade

Real exports 36.1 -13.3 2.5 March

Exports of Goods & Services (const. prices) 38.9 -11.8 2.0 3.0

Real imports 9.6 4.5 -3.6 March

Imports of Goods & Services (const. prices) 14.1 4.3 -3.0 2.0

Contribution to Growth 3.6 -2.6 0.8 0.2

Memo Items (Supply Side):

Hours worked 1.9 1.1 3.1 February

Manufacturing output 24.0 2.0 5.2 February

percent, q/q saar, underlining denotes IIF forecasts

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Then How Do We Make Forecasts?

3. Incorporate the latest information into the Forecast

•benchmark models

•judgmental forecast

Japan

Tracking the Current Quarter

Q3 11 Q4 11 Q1 12 Q2 12 Data

to date through

Real GDP 7.1 -0.7 3.2 2.0

Consumption

Retail Sales 2.0 -4.1 21.7 February

Real Private Consumption 3.5 1.3 3.2 February

Auto Sales (million units, saar) 3.2 3.1 3.9 March

Consumption (constant prices, NIPA) 4.2 1.4 3.0 0.8

Investment

Machinery Orders (Domestic Private) -2.5 0.4 1.2 February

GFCF (NIPA) 1.7 10.3 1.5 2.3

Inventory Contribution to Growth (% points) 0.8 -1.2 0.2 0.7

Trade

Real exports 36.1 -13.3 2.5 March

Exports of Goods & Services (const. prices) 38.9 -11.8 2.0 3.0

Real imports 9.6 4.5 -3.6 March

Imports of Goods & Services (const. prices) 14.1 4.3 -3.0 2.0

Contribution to Growth 3.6 -2.6 0.8 0.2

Memo Items (Supply Side):

Hours worked 1.9 1.1 3.1 February

Manufacturing output 24.0 2.0 5.2 February

percent, q/q saar, underlining denotes IIF forecasts

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Short-term

Forecasts based on highest available frequency

Consumption: Real private consumption index

• auto sales, retail sales, store sales

Exports and Imports:Real export and import indices:

• 10-day customs trade• 20-day customs trade • Industrial Production

Business Investment: IP Report, BoJ Tankan Survey, Cooperation Survey

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Medium Term

•Leading indicators

• Shoko Chukin Survey• Economy watchers Survey• PMI (manufacturing/services)• Consumer Confidence Ind.• Survey of Unemployment

Trends • Lending Survey

•Political Economy

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Medium Term

•Watch for base effects (inflation)

•mean reversion (inventories like an error term)

•statistical carryover

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Long-term

Adopt a view

1. Benchmark: assumptions for potential growth (aging population, declining saving rate)

2. Adopt a view• Make adjustments for other known developmentsExample:

• External Factors: Euro Area crisis, China• Domestic Factors: political stability (elections)

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1956 1961 1966 1971 1976 1981 1986 1991 1996 2001 2006 2011

How far Ahead Can We Forecast?

Percent change, oya, CY

Japan’s Real GDP Growth Rate

9.7%1956-69

5.2%1970s

3.7%1980s

1.5%1990s

0.8%2000s

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A Case Study: JAPAN

percent change over previous period, seasonally adjusted, at an annual rate, unless otherwise stated              

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      2010 2011 2012 2013 11Q3 11Q4 12Q1 12Q2 12Q3 12Q4   2011 2012 2013

Real GDP 4.5 -0.7 2.2 1.5 7.1 -0.7 3.5 2.0 1.5 1.5   -0.6 2.1 1.5

  Consumption 2.6 0.0 2.0 0.4 4.2 1.4 3.5 0.8 0.8 0.0   0.6 1.3 0.4

  Government Spending 2.1 2.1 1.2 1.0 1.1 1.5 1.0 1.0 1.0 1.0   1.9 1.0 1.0

  Fixed investment -0.1 0.6 3.4 2.1 1.7 10.3 1.1 2.3 1.8 1.8   3.3 1.8 2.3

    Business 0.8 1.0 5.1 3.2 1.2 20.7 1.0 3.0 3.0 3.0   4.5 2.5 3.5

    Government -0.2 -3.2 -1.2 -1.1 -6.1 -8.4 0.0 0.0 -2.0 -1.0   0.2 -0.8 -1.0

    Residential -4.6 5.1 2.4 1.5 19.1 -2.7 3.0 2.0 2.0 0.0   2.9 1.7 1.5

  Change in Inventories (¥ trillion, chained)

-1.3 -3.6 -2.6 1.1 -2.6 -4.1 -3.8 -2.9 -2.4 -1.3   — — —

  Exports of Goods and Services 24.4 0.0 1.7 2.4 38.9 -11.8 2.0 3.0 3.0 3.0   -1.6 2.7 2.0

  Imports of Goods and Services 11.1 5.8 2.7 2.9 14.1 4.3 -3.0 2.0 3.0 3.0   5.8 1.2 2.7

GDP Deflator -2.1 -2.1 -0.8 -0.5 -1.3 -0.9 0.0 -0.8 -0.8 -0.8   -1.8 -0.6 -0.3

Nominal GDP 2.3 -2.8 1.3 1.0 5.8 -1.8 3.6 1.2 0.7 0.7   -2.4 1.5 1.2

Contribution to Changes in Real GDP:                              Domestic final sales 2.0 0.5 2.1 0.8 3.1 3.1 2.5 1.1 1.0 0.5   — — —

  Net Exports 2.0 -0.7 -0.1 0.0 3.6 -2.6 0.8 0.2 0.1 0.1   — — —

  Inventories 0.7 -0.4 0.2 0.7 0.8 -1.2 0.3 0.7 0.4 0.9   — — —

  Discrepancy -0.2 -0.1 — — -0.4 0.0 — — — —   — — —

Index of Manufacturing Production 16.6 -2.3 8.1 5.2 24.0 2.2 15.0 8.0 5.0 5.0   0.0 8.2 5.0

Real-Time Forecasts for the World Economy:A Practitioner's Perspective

Robin Koepke and Emre Tiftik

Global Macroeconomic Analysis DepartmentInstitute of International Finance

George Washington UniversityWashington, DCApril 26, 2012

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IIF OECD IMF Consensus Fed (Q4/Q4)

Chart 23U.S.: The Evolution of 2011 GDP Growth Forecastspercent, y/y, forecasts as of the end of quarter

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IIF Consensus European Commission OECD IMF

Chart 32Euro Area: The Evolution of 2011 GDP Growth Forecastspercent, y/y, forecasts as of the end of quarter

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