ECONOMIC FORECASTS



Economic forecasts are widely used at the firm, industry, and economy-wide level. For a firm, economic forecasts facilitate planning for future production, expansion, or contraction. For example, a retailing firm that has been in business for the last 25 years may be interested in forecasting the likely sales volume for the coming year. Similarly, the auto industry may want to know the total demand for vans in the coming model year. Both production plans and the extent of competition in the automobile industry may depend on the magnitude of the forecasted auto demand. At the economy-wide level, one may want to know the economic forecast for growth in the real gross domestic product. One may also be interested in other macroeconomic variables such as the projected inflation rate. There are numerous techniques that can be used to generate economic forecasts.

While the term "economic forecast" may appear to be rather technical, planning for the future is a critical aspect of managing any organization—business, nonprofit, or other. In fact, the long-term success of any organization is closely tied to how well the management of the organization is able to foresee its future and to develop appropriate strategies to deal with likely future scenarios.

Intuition, good judgment, and an awareness of how well the economy is doing may give the manager of a business firm a rough idea (or "feeling") of what is likely to happen in the future. Nevertheless, it is not easy to convert a feeling about the future into a precise and useful number such as the next year's sales volume or the raw material cost per unit of output.

Suppose that a forecast expert has been asked to provide estimates of the sales volume for a particular product for the next four quarters. How should one go about preparing the quarterly sales volume forecasts? One will certainly want to review the actual sales data for the product in question for past periods. Suppose that the forecaster has access to actual sales data for each quarter over the 25-year period the firm has been in business. Using these historical data, the forecaster can identify the general level of sales. He or she can also determine whether there is a pattern or trend, such as an increase or decrease in sales volume over time. A further review of the data may reveal some type of seasonal pattern, such as peak sales occurring before a holiday. Thus by reviewing historical data over time, the forecaster can often develop a good understanding of the previous pattern of sales. Understanding such a pattern can often lead to better forecasts of future sales of the product. In addition, if the forecaster is able to identify the factors that influence sales, historical data on these factors (or variables) can also be used to generate forecasts of future sales volumes.

FORECASTING METHODS

There are many forecasting techniques available to assist in business planning. All forecasting methods can be divided into two broad categories: qualitative and quantitative. Many forecasting techniques use past or historical data in form of time series. A time series is simply a set of observations measured at successive points in time or over successive periods of time. Forecasts essentially provide future values of the time series on a specific variable such as sales volume. Division of forecasting methods into qualitative and quantitative categories is based on the availability of historical time series data.

When historical data are not available, qualitative forecasting techniques are used. Such techniques generally employ the judgment of experts in the appropriate field to generate forecasts. Quantitative forecasting methods are used when historical data on variables of interest are available—these methods are based on an analysis of historical data concerning the time series of the specific variable of interest and possibly other related time series.

There are two major categories of quantitative forecasting methods. The first type uses the past trend of a particular variable to base the future forecast of the variable. As this category of forecasting methods simply uses time series on past data of the variable that is being forecasted, these techniques are called time series methods. The second category of quantitative forecasting techniques also uses historical data. But in forecasting future values of a variable, the forecaster examines the cause-and-effect relationships of the variable with other relevant variables such as the level of consumer confidence, changes in consumers' disposable incomes, the interest rate at which consumers can finance their spending through borrowing, and the state of the economy represented, by such variables as the unemployment rate. Thus, this category of forecasting techniques uses past time series on many relevant variables to produce the forecast for the variable of interest. Forecasting techniques falling under this category are called causal methods, as the basis of such forecasting is the cause-and-effect relationship between the variable forecasted and other time series selected to help in generating the forecasts. Some economic forecasts are generated using a hybrid of the above two methods.

[ Anandi P Sahu , Ph.D. ]

FURTHER READING:

Anderson, David R., Dennis J. Sweeney, and Thomas A. Williams. An Introduction to Management Science: Quantitative Approaches to Decision Making. 8th ed. Minneapolis/St. Paul: West Publishing, 1997.

——. Statistics for Business and Economics. 7th ed. Cincinnati: SouthWestern College Publishing, 1999.



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