Practice and Prospects of Medium-Term Economic Forecasting

Abstract

Government agencies and other national and international institutions are asked to perform forecasts over the medium term. In particular, the EU Stability and Growth Pact contains the obligation to formulate stability programmes over four years, covering a general economic outlook as well as the projected development of public finances. However, the current practice of performing medium-term economic projections is unsatisfactory from a methodological point of view as the applied methodology has been developed for short-run forecasting and it is questionable whether these methods are useful for the medium term. In particular, currently medium-term projections are mostly based on the neoclassical Solow growth model with an aggregate production function with labour, capital, and exogenous technological progress. It might be argued, however, that for medium-run projections endogenous growth models might be better suited. In this paper we give an overview of currently used methods for medium-term macroeconomic projections. Then we analyse the performance of medium-term forecasts for Austria to illustrate the strengths and weaknesses of the typical approach. In particular, the five-year projections of real GDP growth, inflation and the unemployment rate are investigated. Finally, we describe some approaches to improve medium-run projections.