by Scott Schuh
Issue Number 1 (January/February) — 2001

Despite a significant decline in the pace of economic growth in the second half of 2000, macroeconomic forecasters underpredicted real GDP growth and overpredicted the unemployment rate by a significant amount, for the fifth consecutive year. On average, real GDP forecasts were about 2 percentage points below the actual data for the 1996-2000 period, and unemployment rate forecasts about 0.5 percentage point above. On a more positive note, forecasters ended their chronic overprediction of inflation during much of this period. Nevertheless, surprisingly large and persistent errors in recent forecasts of GDP, inflation, and unemployment have perplexed macroeconomists and policymakers for quite some time, and they merit closer examination.

This article evaluates forecast errors in an attempt to understand why recent forecasts have gone awry. The investigation centers on errors in forecasts of real GDP growth, inflation, the unemployment rate, and nominal and real short-term interest rates since 1969. The focus is on one-year-ahead forecasts because well-known lags in the effects of monetary policy require the Federal Reserve to forecast economic activity well ahead when setting its current interest rate target. In addition to studying average forecast errors, the author looks briefly at the time series properties of the work of some individual forecasters.

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