Macroeconomic Projections: Where Science Meets Art

Macroeconomic projections help policymakers navigate an inherently uncertain economic landscape. Their value lies not only in the pointwise numbers they produce, but also in the disciplined process through which models and expert judgement shape narratives that support sound policymaking.

Many factors constrain macroeconomic forecasting, but not its relevance

Macroeconomic forecasting can be a humbling experience for every economist. Macroeconomic experts enter each projection round knowing that the eventual outcome will almost certainly differ from the pointwise forecast. An estimate stated to one decimal place is unlikely to match a continuously evolving economy exactly.

The limitations of macroeconomic forecasting are not merely technical, but also more fundamentally philosophical. Unlike a closed physical system, the economy is shaped by countless interactions among households, firms, the government, financial markets and the international environment. Even if we were able to capture all these relationships conceptually and had a supercomputer powerful enough to evaluate them, the economy would still be exposed to unforeseen shocks that can rapidly alter, or even overturn, established relationships and behavioural patterns. The economy therefore cannot be treated as a laboratory in which the current set of conditions is held constant and our forecasts are fully deterministic and testable. It is precisely this absence of a controlled experimental environment that gives rise to what economists sometimes call “physics envy”.

There is a further complication. Projections produced by policy institutions are exposed to the problem of endogeneity. To understand this in simpler terms we can resort to wisdom embedded in every sci-fi time travel movie, where once people learn about the future, they are immediately prompted to change their behaviour, thereby changing the future itself. Similarly, central bank projections can influence policy decisions, market prices, investor behaviour and the expectations of firms and households. A projection itself can therefore help bring about an outcome that differs from the path it originally described.

These challenges are not a reason to dismiss macroeconomic projections. On the contrary, institutional projections remain one of the most important inputs into economic policymaking. To understand why, it is important to set principles according to which they should be appropriately interpreted. In economic policy decisions, macroeconomic projections should primarily be seen as a diagnosis of the economy and its outlook, given the current set of conditional information, rather than, for example, as a weather forecast. Even less appropriate tend to be cynical comparisons with sports predictions or fortune-telling, which understandably tend to make economists particularly uneasy. The interpretation of macroeconomic projections is also discussed in Banka Slovenije’s podcast, Centralni pogled.

Macroeconomic projections: a diagnosis rather than a promise about the future

A doctor assesses a patient's current condition using a range of indicators, considers how those indicators have evolved and forms a view about how the patient's health may develop under plausible future conditions. If cholesterol has risen, for example, the doctor may judge that cardiovascular risks will increase, particularly if the patient is entering a period of greater stress or less healthy habits. The doctor may then prescribe treatment. If that treatment succeeds, the original prognosis will not materialise. Yet the evaluation of expected health development was valuable precisely because it prompted action.

The diagnosis itself may also change the patient's behaviour without the treatment. It may encourage healthier choices or, in the case of reassuring results, lead to complacency. Unexpected events can alter the outcome as well. None of this makes medical appointments pointless. It simply reflects the fact that a prognosis is conditional and that many relevant factors lie beyond the doctor's control.

The parallel with central bank projections is close. Projections inform interest-rate and other policy decisions, the economic equivalent of prescribed treatment. These decisions are intended to steer the economy towards policy objectives and may therefore move it away from the initially projected path. If staff projections indicate that inflation is likely to remain persistently above the ECB’s 2% medium-term target, for example, the Governing Council may raise key policy rates in an attempt to influence broader financing conditions, aggregate demand and, ultimately, the medium-term inflation outcome itself. Similarly, a more favourable macroeconomic outlook may increase projected government revenues, creating additional fiscal space for higher public spending and thereby stimulating economic activity beyond what was assumed in the initial projection.

Even without an active policy response, a credible projection can influence the eventual outcome by shaping expectations, confidence and the decisions of firms and households. Unlike a weather forecast, therefore, a macroeconomic projection is not merely a passive glimpse into the future. Once published, it can itself become one of the factors shaping that future. Moreover, returning to the analogy with the patient, apart from the effect of the diagnosis, the economy also remains vulnerable to unforeseen shocks. In recent years this has been demonstrated by the series of unpredictable events, such as the outbreak of the Covid-19 pandemic, Russia’s invasion of Ukraine, and revival of trade protectionism.

Good economic policy requires a credible narrative, and macroeconomic projections are central to shaping it

This has important implications for how institutional projections should be assessed. Measures such as the root mean squared error (RMSE) are useful indicators of forecast accuracy, but forecast errors alone do not provide a complete assessment of a projection’s quality or policy usefulness. Differences between a projection and the eventual outcome may reflect policy responses to identified risks, revisions to the data used in initial forecast, or shocks that could not reasonably have been anticipated at the time.

Central banks therefore update their projections frequently. Within the European System of Central Banks, projection rounds and interim updates allow new data, revisions to historical series, changes in the external environment and evidence about the effects of earlier policy decisions to be incorporated into the outlook. Updating the outlook is therefore not an admission that forecasting has failed. Refusing to revise a forecast in the face of new evidence would be.

But, if projections are regularly revised and no single accuracy statistic can provide a complete verdict, what makes them credible? The answer lies in the method and the transparency of the process.

Macroeconomic projections, a coherent story written by models and expert judgement

Policy institutions do not rely on rules of thumb. They draw on a broad range of analytical tools grounded in economic theory and quantitative methods. Statistical models help assess the range of plausible outcomes, while structural macroeconomic models provide theoretical discipline and trace the channels through which different parts of the economy interact. Together, these tools provide a structured basis for forming a coherent and interpretable view of the outlook.

Yet an economy is an open and evolving system, and its relationships are never perfectly stable. Institutional projections are therefore not mechanical outputs generated by a single model. Model-based estimates are combined with expert judgement and are conditional on assumptions about the external environment and other relevant factors. The resulting narrative brings together model evidence, specialist knowledge and broader information, including market expectations.

In this sense, macroeconomic projections combine science and art. The science lies in rigorous methods, data, economic theory and reproducible analysis. The art lies in identifying and interpreting imperfect evidence, reconciling competing signals and constructing a coherent and defensible account of the outlook. This is not a weakness. A transparent narrative makes the projection understandable, exposes its assumptions to scrutiny and creates accountability for the policy decisions based on it. A fully automated workflow might be able to produce numbers, but it could not by itself provide the explanation, structured communication, ownership and accountability.

Delivering the story is just as important as crafting it

The complex process of shaping the messages behind macroeconomic projections also requires careful consideration of their intended audience. In an environment of continuous news flows, central banks understandably face pressure to communicate their messages briefly, quickly and clearly enough to be easily understood and remembered by the public. Yet the communication of monetary policy and other economic policies does not operate solely through the general public. Financial markets, the banking system, government, international institutions and businesses are also important audiences. For these groups, more detailed and in-depth communication remains essential, as it explains not only what the projection is, but also why it has changed and how it has informed economic policy decisions.

This is equally, if not even more, important for smaller central banks. Although Slovenia represents only a small share of the euro area economy, Banka Slovenije’s projection process is subject to the same methodological discipline, expert scrutiny and review that characterise the preparation of macroeconomic projections across the Eurosystem. Banka Slovenije’s assessments also provide an important reference point for domestic economic agents, international institutions, credit rating agencies and investors, whose prior familiarity with the Slovenian economy and accessibility of alternative projections may be more limited than in the case of larger economies.

Without an independent assessment of economic developments and an outlook for the economy provided by Banka Slovenije, uncertainty among international institutions, investors and trading partners could therefore increase, while their understanding of domestic economic conditions could diminish. This could have broader real and financial consequences for the Slovenian economy and its development.