A forecast is an estimate of economic conditions in the future. Businesses and governments use them to help determine strategies, multi-year plans, and budgets. Investors look at them to get a sense of a company’s prospects and the valuation of its stock.
Formal economic forecasts are usually based on a theory of how the economy works. Some are complex, involving detailed tracing of cause and effect. Others are much simpler, focusing on one or two fundamental factors. For example, some economists believe that the supply of money determines the rate of growth in general business activity, while others believe that investment in new facilities such as factories, houses and highways is a key driver of economic expansion.
The quality of a forecast depends on the extent to which it is grounded in broad economic considerations and standard statistical techniques. Good forecasts also take into account the particular factors that are important to a given industry or firm. For example, sales of a certain product may correlate fairly directly with various elements of the national income and product accounts–lumber sales with home construction, for instance, or nondurable consumer goods sales with household spending and total consumer spending.
Nevertheless, even when an analyst has used a range of standard methods, a subjective element of judgment is often introduced. This is largely because the economic forecaster’s own theories about how the economy works affect the type of indicators to which she or he pays attention. The result can be a prediction that is too optimistic or too pessimistic.