The Forecasting Power of Economic Growth Models

Abstract: High forecasting power is essential for understanding scientific relationships. In economics, forecasting power may be decisive for the success or failure of a particular policy. The forecasting power of economic growth models is investigated in this study. Regressions from one dataset including the gross domestic product (GDP), GDP growth, trade openness, the quality of public institutions and secondary education generate insufficient forecasting power with respect to growth. Furthermore, the International Monetary Fund's one-year growth forecasts are compared to outcome. Forecasts for 1999-2006 were found to be significantly different from outcome during 7 years out of 8. The forecast error slightly exceeded 1 percentage unit, which is similar to results from earlier studies on forecast error and equal to the forecast/hindcast error from a simple multivariate model constructed from historical growth data. Possible reasons behind poor forecast quality are discussed, including the tradition to build models using assumptions from irrefutable theoretical constructs.