The Forecasting Process

In its semiannual Economic Outlook for Austria (published in June and December), the OeNB provides projections for the growth of Austrian GDP and its components as well as for the development of domestic prices in the current and the upcoming two years. These forecasts are drawn up in cooperation with the other national central banks (NCBs) in the euro area and the ECB. The data they yield are inter alia used in the Eurosystem staff macroeconomic projections for the euro area, which serve as an important basis for decision-making in the Governing Council of the ECB under the second pillar of the monetary policy strategy. The Eurosystem staff macroeconomic projections are a tool for organizing and aggregating existing information on current and future economic developments in the individual euro area countries and in the euro area as a whole. 

The OeNB’s forecasts for Austria are based on a macroeconomic quarterly model, which, unlike the annual models other institutions use, allows for a depiction of intrayear (i.e. quarterly) trends regarding individual forecasting components (see below).

The semiannual Eurosystem staff macroeconomic projections for the euro area are the product of a three-step process.  First, ECB and Eurosystem NCB experts have to agree on common external assumptions, based on which the individual NCBs then draw up forecasts for their respective countries.  In a next step, these country projections are aggregated to yield the macroeconomic projections for the entire euro area.  These are then reported to the Governing Council of the ECB.  Finally, the Eurosystem staff macroeconomic projections for the euro area are published in the ECB’s Monthly Bulletin, and the OeNB presents its Economic Outlook in its publication Monetary Policy & the Economy and on its website. 

• Step 1: At the beginning of each forecasting round the technical assumptions regarding short- and long-term interest rates, exchange rates and commodity prices are determined.  Short-term interest rates (the three-month EURIBOR) are assumed to remain constant over the horizon of the projection.  Assumptions concerning long-term interest rates reflect market expectations for 10-year government bonds.  Exchange rate assumptions are based on an average of recent rates and kept unchanged over the entire forecast period.  The assumptions regarding oil and other commodity prices mirror the respective forward rates.  The assumed development of external macroeconomic conditions, e.g. growth in the U.S.A., is agreed in extensive discussions between ECB and NCB experts, an approach which is to ensure the best possible use of expert knowledge in the Eurosystem.  The OeNB, for instance, is in a position to provide special know-how on Central and Eastern Europe.  The external forecasting assumptions for Austria are also influenced by the forecasts of other euro area countries, in particular Germany and Italy.  
• Step 2: Once the external assumptions have been defined, the OeNB’s derive a country projection for Austria, i.e. use a macroeconomic model to derive projections for GDP growth, labor market conditions and the development of prices and costs in the current year and in the following two years.  The forecast for GDP growth reflects the aggregate projections for the individual expenditure components of GDP, i.e. private and public consumption, exports and imports, gross fixed capital formation and inventory changes.  Price developments are also projected separately for each component.
• Step 3: Once the Eurosystem experts have extensively discussed the NCBs’ forecasts and have verified the overall consistency of data, they produce the Eurosystem staff macroeconomic projections for the euro area by aggregating the individual country data.  The macroeconomic projections for the euro area, which are presented to the Governing Council of the ECB together with a detailed report, provide an important basis for monetary policy decisions under the second pillar.  The projection results, which are published in the ECB’s Monthly Bulletin (in June and December), have an important signaling function.  The publication of the macroeconomic projections for Austria is synchronized with the publication of the results for the entire euro area.  The OeNB explains its projections for Austria in great detail in its publication Monetary Policy & the Economy (issues 2 and 4 of each year) and makes available summarized versions on its website. 

The OeNB’s macroeconomic forecasts are based on the technical assumption that short-term interest rates and the bilateral exchange rates of the euro vis-à-vis other currencies remain unchanged over the entire forecast horizon.  This is intended to help the Governing Council of the ECB to assess economic developments removed from future monetary policy influences.  However, as monetary policymakers will always act to contain threats to price stability emanating from changes in the economic environment, the projections will not necessarily be the best unconditional predictor of future outcomes –  in particular toward the end of the forecast horizon.

Methodologically speaking, the macroeconomic forecasting process at the OeNB can be broken down into three steps.  OeNB experts first produce short-term forecasts for the current and the upcoming quarter and then prepare initial projections for the entire forecast horizon with the OeNB’s macroeconomic model.  These results may subsequently be revised should OeNB experts judge current developments to be reflected inadequately by the model equations. 

• Short-Term Forecasts: As the first step in the overall forecasting process, short-term forecasts yield estimates of economic developments in the current and the upcoming quarter, which are to provide a good overview of the present cyclical environment.  The short-term forecasts are derived with two time series-based econometric models which utilize the leading indicator properties of certain macroeconomic time series (e.g. confidence indicators).  The paramount objective of this first step is to minimize the number of iteration rounds necessary for ensuring consistency among the different national euro area country projections by providing sound GDP and import growth values from the beginning. 
• The OeNB’s Macroeconomic Model: For the projections as such the OeNB uses a quarterly structural econometric model.  The long-term relationships which stabilize this model are based on the assumption that, in the long run, output is determined by technological progress and the available labor and capital input.  The short-term properties are less theory based; they are derived from historical data (and their predictive properties) and reflect market rigidities.  In accordance with the ECB framework, the OeNB’s macroeconomic model does not contain any equations which presuppose forward-looking action on the part of economic agents.  The model, which is continuously updated and expanded, currently consists of 146 variables and 128 equations (behavioral and definitional equations).  At present, the OeNB’s model is the only macroeconomic model for Austria which relies on quarterly data and which is used for forecasting purposes.  Unlike the commonly used annual growth rates, quarterly growth rates make it possible to depict the intrayear development of the individual forecasting components.  
• Expert Knowledge: As econometric models usually cannot (or do not sufficiently) accommodate special factors or structural breaks, the final analysis of results must rely on the judgment of OeNB experts.  Their assessment of the current economic environment forms the basis for final adjustments to the model-based projection results. 

The Eurosystem staff macroeconomic projections for the euro area are based on an aggregation of the individual NCBs’ country projections.  Thus, consistency within and among the individual forecasts is of paramount importance.  In particular, the sum of intra-euro area exports must correspond to that of intra-euro area imports to allow reliable estimates for the euro area.  To guarantee consistency, the NCBs’ import and export projections are harmonized during several iteration rounds.  This is of particular significance in the case of a small open economy like Austria, as the import demand of other euro area countries is an important determinant of future economic development. 

All forecasts are surrounded by a varying amount of uncertainty.  Forecast risks are assessed by calculating scenarios which represent economic developments under different external macroeconomic conditions against the baseline.  Typical scenarios include alternative assumptions concerning the future development of oil prices, exchange rates or economic growth in important economic regions as, for instance, the United States.  The scenarios not only include calculations of direct effects e.g. of an oil price rise on the Austrian economy, but also indirect effects which may arise through demand and price changes in other euro area countries.