Why do financial markets rise and fall with every announcement of how a country's economy fared? Why does the media consult economists for their views, and why do views invariably differ, sometimes by quite a lot?
Singapore's Ministry of Trade and Industry forecasts the Singapore economy to grow between 1- 3% for 2016. Is this information useful? A 2% admission of possible margin of error is a lot. 2% of Singapore's GDP of about US$300 billion is US$6 billion. Enough to give each of our 3.27 million citizens US$1,834.00
So what is the value of economic forecasting particularly when it is always being revised up and down as the situation changes? Rationale for still coming out with forecasts:
1. No matter how unreliable macroeconomic forecasts are policy makers still need to have forecasts for decision-making and planning. They cannot rule out the uncertainty but they can do Scenario Planning viz. if scenario A, then do this scenario B then do that.
2. At least a range forecast of between x and y% is better than a point forecast of just x%. Because range forecasting is about the statistical distribution of forecasts (probably generated by a Monte Carlo simulation).
Based on the assumption of a Normal Distribution like in the image above, if the forecasts have a Mean (Average) of 2% they can at least say that the probability of growth being between 1 and 3 % is 95% (+/- 1 Standard Deviation).
Depending on the skewness of the actual distribution (tilted towards left or right), they can also say whether its more likely to be in the higher or lower end of the range.
Economic forecasts do have some use and value. But it is ultimately based on availability of good data and the construction of a good forecast model- something very difficult to achieve.
Recent advances in economic forecasting include: (1) Having parametric models that specify the distribution of the errors over time (2) Generating non-Gaussian distributions of forecasts through simulation (3) Building models that have equations of the structural components of the economy e.g. a manufacturing function, an import/export function. .