1. Real-Time Forecasts for the World Economy: A Practitioner's Perspective Robin Koepke and Emre Tiftik Global Macroeconomic Analysis Department Institute of International Finance George Washington University Washington, DC April 26, 2012

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3. 3 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.

4. 4 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

5. 5 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

6. 6 Where’s the Model?

7. 7 Appropriate Time of First Policy Rate Hike as per FOMC Number of FOMC participants in favor of time shown on x-axis

8. 8 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

9. 9 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

10. 10 Using Judgment: “Known Unknowns” United States: Fiscal Policy in 2013 Percent of GDP, calendar year basis

11. 11 Our Current U.S. Growth Forecast Contributions to growth in percentage points, saar United States: Real GDP

12. 12 Using Judgment: “Unknown Unknowns” Index, February 2011 = 100 Japan: Industrial Production and Real Exports

13. 13 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

14. 14 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

15. 15 A Case Study: JAPAN

16. 16 A Case Study: JAPAN percent change over previous period, seasonally adjusted, at an annual rate, unless otherwise stated Q4/Q4 201020112012201311Q311Q412Q112Q212Q312Q4 201120122013 Real GDP 4.5-0.72.21.57.1-0.73.52.01.5 -0.62.11.5 Consumption 2.60.02.00.44.21.43.50.8 0.0 0.61.30.4 Government Spending 2.1 1.21.01.11.51.0 1.91.0 Fixed investment -0.10.63.42.11.710.31.12.31.8 3.31.82.3 Business 0.81.05.13.21.220.71.03.0 4.52.53.5 Government -0.2-3.2-1.2-1.1-6.1-8.40.0 -2.0 0.2-0.8 Residential -4.65.12.41.519.1-2.73.02.0 0.0 2.91.71.5 Change in Inventories (¥ trillion, chained) -1.3-3.6-2.61.1-2.6-4.1-3.8-2.9-2.4-1.3 ——— Exports of Goods and Services 24.40.01.72.438.9-11.82.03.0 -1.62.72.0 Imports of Goods and Services 11.15.82.72.914.14.3-3.02.03.0 5.81.22.7 Contribution to Changes in Real GDP: Domestic final sales 2.00.52.10.83.1 2.51.11.00.5 ——— Net Exports 2.0-0.7-0.10.03.6-2.60.80.20.1 ——— Inventories 0.7-0.40.20.70.8-1.20.30.70.40.9 ——— Discrepancy -0.2-0.1——-0.40.0———— ——— Index of Manufacturing Production 16.6-2.38.15.224.02.215.08.05.0 0.08.25.0

17. 17 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 Forecasts Long term: next 6-24 months How far Ahead Can We Forecast?

18. 18 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 Real GDP Releases Percent change, q/q, saar

19. 19 percent change over previous period, seasonally adjusted, at an annual rate, unless otherwise stated Q4/Q4 201020112012201311Q311Q412Q112Q212Q312Q4 201120122013 Real GDP 4.5-0.72.21.57.1-0.73.52.01.5 -0.62.11.5 Consumption 2.60.02.00.44.21.43.50.8 0.0 0.61.30.4 Government Spending 2.1 1.21.01.11.51.0 1.91.0 Fixed investment -0.10.63.42.11.710.31.12.31.8 3.31.82.3 Business 0.81.05.13.21.220.71.03.0 4.52.53.5 Government -0.2-3.2-1.2-1.1-6.1-8.40.0 -2.0 0.2-0.8 Residential -4.65.12.41.519.1-2.73.02.0 0.0 2.91.71.5 Change in Inventories (¥ trillion, chained) -1.3-3.6-2.61.1-2.6-4.1-3.8-2.9-2.4-1.3 ——— Exports of Goods and Services 24.40.01.72.438.9-11.82.03.0 -1.62.72.0 Imports of Goods and Services 11.15.82.72.914.14.3-3.02.03.0 5.81.22.7 Contribution to Changes in Real GDP: Domestic final sales 2.00.52.10.83.1 2.51.11.00.5 ——— Net Exports 2.0-0.7-0.10.03.6-2.60.80.20.1 ——— Inventories 0.7-0.40.20.70.8-1.20.30.70.40.9 ——— Discrepancy -0.2-0.1——-0.40.0———— ——— Index of Manufacturing Production 16.6-2.38.15.224.02.215.08.05.0 0.08.25.0 GDP = Private Consumption + Government Consumption + Fixed Investment (Business + Residential + Government) + Net Exports + Change in Inventories Then How Do We Make Forecasts? Forecasting with Spreadsheets

20. 20 Then How Do We Make Forecasts? 2. Information Gathering Track Your Data (Framework to incorporate latest releases quickly)

21. 21 Then How Do We Make Forecasts? 3. Incorporate the latest information into the Forecast benchmark models judgmental forecast

22. 22 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

23. 23 Medium Term Leading indicators Shoko Chukin Survey Economy watchers Survey PMI (manufacturing/services) Consumer Confidence Ind. Survey of Unemployment Trends Lending Survey Political Economy

24. 24 Medium Term Watch for base effects (inflation) mean reversion (inventories like an error term) statistical carryover

25. 25 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 developments Example: External Factors: Euro Area crisis, China Domestic Factors: political stability (elections)

26. 26 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

27. 27 A Case Study: JAPAN percent change over previous period, seasonally adjusted, at an annual rate, unless otherwise stated Q4/Q4 201020112012201311Q311Q412Q112Q212Q312Q4 201120122013 Real GDP 4.5-0.72.21.57.1-0.73.52.01.5 -0.62.11.5 Consumption 2.60.02.00.44.21.43.50.8 0.0 0.61.30.4 Government Spending 2.1 1.21.01.11.51.0 1.91.0 Fixed investment -0.10.63.42.11.710.31.12.31.8 3.31.82.3 Business 0.81.05.13.21.220.71.03.0 4.52.53.5 Government -0.2-3.2-1.2-1.1-6.1-8.40.0 -2.0 0.2-0.8 Residential -4.65.12.41.519.1-2.73.02.0 0.0 2.91.71.5 Change in Inventories (¥ trillion, chained) -1.3-3.6-2.61.1-2.6-4.1-3.8-2.9-2.4-1.3 ——— Exports of Goods and Services 24.40.01.72.438.9-11.82.03.0 -1.62.72.0 Imports of Goods and Services 11.15.82.72.914.14.3-3.02.03.0 5.81.22.7 GDP Deflator -2.1 -0.8-0.5-1.3-0.90.0-0.8 -1.8-0.6-0.3 Nominal GDP 2.3-2.81.31.05.8-1.83.61.20.7 -2.41.51.2 Contribution to Changes in Real GDP: Domestic final sales 2.00.52.10.83.1 2.51.11.00.5 ——— Net Exports 2.0-0.7-0.10.03.6-2.60.80.20.1 ——— Inventories 0.7-0.40.20.70.8-1.20.30.70.40.9 ——— Discrepancy -0.2-0.1——-0.40.0———— ——— Index of Manufacturing Production 16.6-2.38.15.224.02.215.08.05.0 0.08.25.0

28. Real-Time Forecasts for the World Economy: A Practitioner's Perspective Robin Koepke and Emre Tiftik Global Macroeconomic Analysis Department Institute of International Finance George Washington University Washington, DC April 26, 2012

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