Introduction

In this chapter we consider the role of macroeconomic models in the forecasting process. The use of macroeconomic models has developed extensively since the 1960s. In the US private institutions have been able to obtain forecasts of the US economy based on the Wharton model since 1963 and for the UK the London Business School has been modelling the economy since 1966. Since that date the number of forecasts based on macroeconomic models has been the subject of considerable expansion and Fildes and Chrissanthaki (1988) suggest that over 100 agencies are involved in making macroeconomic forecasts for the UK. Many of these agencies utilise macroeconomic models for this purpose but, for commercial reasons, details of their forecasting methods are not published. In section 5.2 we examine the general nature of macroeconomic models, followed by the presentation of a simple illustrative model in section 5.3. In section 5.4 we demonstrate how forecasts are prepared using this simple model as an example and in section 5.5 consider the role of judgemental adjustments. Forecasts of the 1980–82 recession are examined in section 5.6 and the decomposition of forecast errors in section 5.7. In section 5.8 we discuss the accuracy of macroeconomic forecasts and our conclusions are presented in 5.9.

Nature of macroeconomic models

Essentially a macroeconomic model is an attempt to describe an economy. This description may be presented in verbal form, diagrammatic form or in the form of mathematical equations. Standard macroeconomic texts are firmly based in the first two approaches with some use of mathematics.